The market's 'smart money' is flooding into industrial stocks - but one Wall Street strategist warns investors are setting themselves up for disaster
- Hedge funds are crowding into industrials, according to the top equity strategist for RBC Capital Markets. Those stocks are soaring, but risks to investors are on the rise as well.
- Lori Calvasina says investors could suffer losses if Wall Street's views on industrials shift back to normal, or if worries about slower economic growth increase.
The so-called smart money is piling into US industrial companies, and one top equity strategist says investors might get crushed when the sector runs out of steam.
Major hedge funds snapped up machinery and shipping companies in the fourth quarter, and those stocks have posted market-beating gains in 2019. But when a trade gets too popular, it can create major risks, regardless of fundamental merit, according to RBC Capital Markets head equity strategist Lori Calvasina.
"When crowded trades unwind, it tends to be painful and difficult for investors to get out in time," Calvasina wrote in a recent client note.
The chart below shows just how strong demand has been for industrial stocks. The blue bars show the extent of hedge funds' overweight or underweight positions on the sectors, and the orange dots compare that positioning to the norm since 2010.
As you can see, investors are drastically overweight industrials compared to history.
In terms of what could spur a sudden shift in industrial sentiment - the kind that could send investors fleeing for the exits - Calvasina highlights an economic growth slowdown. Her concerns echo recent signs traders are getting worried about future growth, even amid a giant stock-market relief rally this year.
"Most of our baskets of crowded names struggled in 2016, when the growth trade last stumbled (as it appears to be doing now)," Calvasina wrote.
Economic growth is particularly critical for industrial company profits, as the sector is one of the most tightly linked to overall economic health. And while investors have set aside their fears and pushed industrials up 18% this year, Calvasina says the risks are substantial.
She says stocks in the industry are getting higher ratings from analysts than usual, while hedge funds shift an abnormal additional amount of money into the sector. Overall, Calvasina says industrials hit an all time "overweight" high in the third quarter of last year and came down only a little in the fourth quarter.
That means the stocks could sink if analysts shift their views back to their historical norms, or if hedge funds change their positions.
On the flipside, hedge funds were underweight utilities and household products companies during the fourth quarter and reduced their positions, according to Calvasina. And those sectors have, in turn, lagged the market in 2019.