Right now, active managers of large capitalization funds are crowded into nine stocks in particular, according to the June 30 release of the "Active managers' holdings update" from Bank of America Merrill Lynch, a division of Bank of America Corp. (BAC). Based on historical analysis by Merrill Lynch, there may be an opportunity to profit from taking short positions in these stocks through mid-July. Merrill defines over-owned stocks as those whose weight in the funds studied is more than 1.5 times their weight in the S&P 500 Index (SPX), and which are held by at least 35% of these funds.

Most Over-Owned Stocks

Topping the list as the most over-owned per Merrill's criteria is travel booking service The Priceline Group Inc. (PCLN), whose relative weight (weight in the funds studied vs. weight in the S&P 500) is 2.63x, and which is held by 35.4% of those funds. The other eight are, in descending order of relative weight: payments processor Visa Inc. (V), online merchant Amazon.com Inc. (AMZN), managed health care company UnitedHealth Group Inc. (UNH), Google parent Alphabet Inc. Class C (GOOG), drug maker Biogen Inc. (BIIB), payments processor MasterCard Inc. (MA), Alphabet Inc. Class A (GOOGL) and mass media company Comcast Corp. (CMCSA). (For more, see also: Visa Inc. Announces Q4 and Fiscal Year 2016 Results.)

Most Neglected Stocks

At the opposite end of the spectrum, Merrill Lynch names six neglected stocks whose relative weights are 0.03x or less, and which are held by no more than 2.49% of the funds studied. These stocks are: electric and gas utility SCANA Corp. (SCG), furniture and engineered components manufacturer Leggett & Platt Inc. (LEG), insurer Cincinnati Financial Corp. (CINF), media conglomerate News Corp. (NWS), tax preparer H&R Block Inc. (HRB) and Connecticut-based bank holding company People's United Financial Corp. (PBCT).

Trading Strategy

"Positioning matters more than fundamentals in the short term, and this has been especially true around the quarter-end rebalancing," the Merrill Lynch report says. More specifically, based on data from the end of 2012 onwards, Merrill Lynch finds that crowded (overweight) stocks have underperformed neglected (underweight) stocks.

Going a step further, Merrill Lynch has identified a trading strategy for the first 15 days after a quarter ends. Short selling the 10 most overweight stocks and buying the 10 most underweight stocks as of a quarter end has produced an average annualized gain of 119% over those 15 days. However, if you maintain those positions for 90 days after a quarter ends, the average annualized gain shrinks to 12%.

Over the 18 quarters studied by Merrill Lynch, the annualized gains from the 15-day trading strategy have ranged from -31% to +875%. It produced losses in six of those 18 quarters, and the median annualized gain was 31.5%. For the 90-day holding period, the annualized gains ranged from -42% to +81%. Losses also were produced in six quarters, and the median annualized gain was 15%.

Missing Rationale

In its report, Merrill Lynch does not present a theoretic rationale for its findings. However, as quoted above, Merrill does make a passing reference to quarter-end rebalancing. If portfolio managers consistently cut back on their most overweight positions shortly after a quarter-end, that would depress the prices of these securities, especially if the selling is widespread. Researchers have observed a similar dip in stock prices resulting from selling by mutual, pension and hedge funds around the end of each month, producing short-term buying opportunities, as reported by the Wall Street Journal. (For more, see also: What does the end of the quarter mean for portfolio management?)

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