Stocks could be heading for another selloff according to RBC’s hedge fund hot dog basket

A group of the most popular stocks held by the world’s biggest hedge funds are starting to underperform the market as a whole again. According to a team of analysts at RBC Capital Markets, this is a sign that US equities could be heading for another boom.

For several years now, a team of equity analysts led by Lori Calvasina, RBC’s head of US equity strategy, has been tracking a basket of what it calls “hedge fund hot dogs” – the most popular S&P 500.
SPX,
+1.17%

stocks held by 300 of the world’s largest hedge funds. Analysts update the basket four times a year after hedge funds release their breakdowns of their equity holdings at the end of the quarter.

See: Hedge funds rack up $125 billion betting against the S&P 500’s big summer rally

Since creating the basket, the team has noticed a pattern: when “hedge fund hot dogs” start to underperform an equally-weighted version of the S&P 500, it’s often a sign that a sell-off in action was in store.

This happened in 2018, when the basket started to underperform about a month before the Q4 selloff of that year. And after a brief period of stabilization this summer, hot dogs are underperforming again.

The indicator also worked the other way: Calvasina and his team explained that the outperformance of the “hot dog” in April and May made them optimistic that a near-term bottom was approaching.

The graph below illustrates the performance of the “Hedge Fund Hot Dogs” basket against the equally weighted S&P 500 Index.

Source: RBC

Over the past two weeks, the basket has started to underperform again.

“The weakness in this basket so far in 3Q22, when only 25% of the names on this list have outperformed the S&P 500, is something we are watching closely as it may signal that stocks are generally on the verge of experience another bout of volatility in the coming months,” the team wrote.

Here is a breakdown of basket components ranked by aggregate dollar value owned by RBC’s 300-fund tracker.

Source: RBC Capital Markets

It’s worth noting that megacap tech names like Microsoft Corp.
MSFT,
+0.76%
,
Alphabet Inc.
GOOG,
+2.52%
,
Amazon.com Inc.
AMZN,
+2.42%
,
Meta Platforms Inc.
META,
+3.07%
,
Apple Inc.
AAPL,
+1.25%

and Tesla Inc.
TSLA,
-0.81%

are among the main constituents of the basket.

Many of them are the same stocks that have led the market higher for much of the past decade thanks to the S&P 500’s record high in January.

They also led the market lower in the historic sell-off that followed. during the first semester.

See: US stocks generally up as strong economic data bolsters sentiment ahead of Powell speech

While the S&P 500, the Dow Jones Industrial Average
DJIA,
+0.76%

and compound Nasdaq
COMP,
+1.43%

were each on track to close higher on Thursday, all three benchmarks remained mired in the red for the week. If the S&P 500 and Nasdaq were in Friday’s session at these levels, it would mark their second straight week in the red.

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