In a contrarian view, Goldman Sachs says 12 ‘crowded’ stocks held heavily by both mutual funds and hedge funds are likely to dramatically outperform the rest of the market amid two escalating U.S. trade wars. These ‘shared favorites’, popular among both mutual and hedge funds, come from a strikingly broad range of industries such as airlines, cable, financial payments, health care and tech, and they include Adobe Inc. (ADBE), Booking Holdings Inc. (BKNG), Citigroup Inc. (C), Comcast Corp. (CMCSA), Salesforce.com (CRM), Delta Airlines Inc. (DAL), Mastercard Inc. (MA), ServiceNow Inc. (NOW), PayPal Holdings Inc. (PYPL), Unitedhealth Group Inc. (UNH), Visa Inc. (V), and Alphabet Inc. (GOOGL),

"The underperformance of popular positions today following President Trump’s announcement of tariffs on imports from Mexico underscores investor concern about crowded positions," said Goldman in its latest US Weekly Kickstart report. But, "Despite posing a tactical risk, concentrated ownership has generally been a positive signal for subsequent stock returns," added Goldman.

Estimated Sales and EPS Growth for Goldman's List

The median stock within the current list of shared favorites is expected to grow 2019 sales by 16% and earnings by the same amount, far faster than the growth rate of the hedge fund or mutual fund baskets.

Source: Goldman Sachs

What it Means for Investors

To be sure, any individual stock in this group may be pulled down by negative forces, such as Alphabet, whose shares fell sharply on Monday on news that the U.S. government is launching an anti-trust probe into the company.

But Goldman's popular stocks have done well as a group. Its portfolio of shared favorites from hedge funds and mutual funds has posted an 18% return year to date, way ahead of the 13% return of Goldman's hedge fund VIP basket and also ahead of the mutual fund basket's 15% return. The median stock within the current list of shared favorites is expected to grow 2019 sales by 16% and earnings by the same amount, far faster than the growth rate of the hedge fund or mutual fund baskets. Goldman says the shared favorites are also expected to have higher margins. However, the median stock in the shared favorites group has a dramatically higher price-to-earnings ratio of 26.

Many investors worry that overly popular stocks are risky bets as they often are overvalued and offer minimal prospects for further price appreciation. But historical data tells a different story. In the case of most popular hedge fund holdings, Goldman found that in 65% of the quarters since 2009, the top 20% -- or most popular stocks -- based on number of hedge fund owners outperformed the least popular, bottom 20%.

Goldman also found that popular, high-valuation stocks have posted a median 12- month return of 13%, much better than the median 8% return for unpopular, low valuation stocks. 

Looking Ahead

There is a caveat. Goldman warns that crowded positions have generally underperformed during falling equity markets. The shared favorites portfolio has outperformed in 60% of the weeks in which the S&P 500 has posted a positive return since 2013, but it has outperformed in just 44% of the weeks where the S&P 500 had posted a negative return. If the trade war escalates enough to spark a bear market, investors may want to shy away from crowded positions.