When stock market sentiment suddenly turns bearish, the exits are bound to get crowded. As a result, cautious investors should be wary of owning stocks that are likely to come under heavy selling pressure from funds that trade heavily. "In times of stress, investors need to focus on who owns what stocks, which funds are more likely to 'blow out' a name and impact performance," as Steven DeSanctis, an equity strategist at Jefferies, warned in a note to clients cited by CNBC.
"The thought here is that when the market gets rocky, who is likely to purge names and who would likely add to positions. Knowing this may help investors decide whether to buy or sell a stock; also just to understand who owns names that you hold is becoming increasingly important," DeSanctis added. The table below lists 10 stocks that Jefferies finds are particularly vulnerable to mass selling by hedge fund managers with short investment horizons and a hair-trigger approach to trading.
10 Stocks Vulnerable to a Downdraft
(Weightings in High-Turnover Hedge Funds)
- Amazon.com Inc. (AMZN), 1.8
- Facebook Inc. (FB), 0.9
- Red Hat Inc. (RHT), 0.7
- Boeing Co. (BA), 0.6
- Alphabet Inc. (GOOGL), 0.5
- Honeywell International Inc. (HON), 0.5
- Visa Inc. (V), 0.5
- Netflix Inc. (NFLX), 0.5
- Bank of America Corp. (BAC), 0.4
- Adobe Systems Inc. (ADBE), 0.4
Source: Jefferies, as reported by CNBC
Significance for Investors
To find crowded trades that may unwind rapidly, putting severe downward pressure on prices, Jefferies looked at quarterly SEC Form 13F filings for the top 100 hedge funds, using this data to identify the 25 funds that trade stocks most frequently, and to determine which stocks are most heavily owned by them. Tech stocks dominate the list above, contributing 7 of the 10, the result of heavy buying by hedge funds during their Dec. 2018 bottoms.
"U.S. economic growth has sharply decelerated since early December. Consensus revenue growth estimates for S&P 500 firms also have been cut," as Goldman Sachs observes in a recent release of their US Weekly Kickstart report. Presently the market appears to be shrugging off these negative trends, but they eventually may touch off the mass selling that Jefferies warns against.
Meanwhile, investors who bet on momentum, chasing the best-performing stocks in the expectation that they will continue to lead, should exercise some caution of their own, according to Sarah McCarthy, an Ireland-based global quantitative and European equity strategist at investment management firm Bernstein, per Barron's. She notes that high momentum stocks ended 2018 at higher valuation premiums versus low momentum stocks than in 2009, when they suddenly plummeted by 53% within six months.
"There is a high level of fragility in the [momentum] factor," McCarthy warned in a report quoted by Barron's. "We strongly caution against exposure to the factor and retain our short position," she added.
At the other end of the spectrum, Jefferies also identifies stocks that are among the top holdings of the 25 hedge funds in their study sample that are the least active traders. These stocks theoretically should not be at risk from mass selling by hedge funds, and the top names on this list are Seattle Genetics Inc. (SGEN), Procter & Gamble Co. (PG), Incyte Corp. (INCY), CVR Energy Inc. (CVI), and Microsoft Corp. (MSFT). Interestingly, both Amazon.com and Facebook, favorites of the high turnover hedge funds, also are among the top 10 holdings of the low turnover funds as well.