Charts of the Week

Happy Thanksgiving to all those who celebrate. This special edition of Charts of the Week focuses on a key topic we’ve been discussing for some time. The concentration of positioning by hedge funds in the so-called Magnificent 7 stocks.

Exposure Levels are Audacious

Hedge funds increased their allocation to Magnificent 7 stocks to a new all-time high in Q3, accounting for 13%, which is twice the allocation level we saw to start 2023.

The Goldman Sachs Hedge Fund Crowding Index suggests that this is the most crowded these funds portfolios have ever been into the same trades, exceeding the crowding seen in 2016 by just enough to make a historic high.

In fact, hedge fund mega cap exposure as a total share of US single stock allocation is at the 99th percentile, suggesting it’s an extremely crowded trade, up from just 12% to start 2023.

Seen another way, mega cap tech exposure as a percentage of total US single stock net exposure is near all-time highs, only tracing modestly back recently. However, given that this chart is about two weeks old we may be back at all-time highs of aggregate exposure now.

Hedge funds also have near-record exposure to momentum, with the highest level ever recorded in 2016.

This rush into mega caps, leaving the rest of the S&P 500 behind, has led to just seven companies accounting for 29% of market capitalization within the index. A secondary effect of the extremely narrow rally we’ve seen year-to-date.

The Excitement is Contagious

All the excitement has led to extremely high NASDAQ 100 futures exposure as fund managers chase the rally.

This frenzied buying also led to the NASDAQ to become overbought for the first time since summer, just before Nvidia released earnings that didn’t impress investors.

There are other signs of euphoric optimism as well, as we can see in the CBOE equity put/call ratio chart below. Last week call volume exceeded put volume by more than 2-to-1 which to me suggests that traders are becoming very excited about the potential for further upside.

But Mega-Cap Valuations are Outrageous

All of this chasing of performance, particularly within the Magnificent 7, has resulted in an exceedingly stretched forward P/E of 29.5. The S&P 500 itself is trading at a P/E of 19, and the implied “fair value” for the market if the US 10-year yield is 4.44% is a P/E 15.1, suggesting that there remains ample froth in this market unless rates fall or earnings improve (or both).

And Equal-Weight Performance is Disadvantageous

While the market cap weighted S&P 500 has delivered an impressive 17% year-to-date return, the equal-weighted index has only risen about 2%. Since 1982 from bear market lows to new bull markets we’ve seen equal-weight and small cap factors lead, but this rally has not seen that distribution in participation to the upside with many smaller companies left out of the run. Suggesting that managed money is also hiding out in the mega caps as a proxy for safer investments.

Calling for a Hard Landing is Courageous

The consensus is very much for a soft landing (or even no landing at all), with 74% of fund managers confident of that economic outcome in 2024. Only 21% of those surveyed believe a hard landing may be coming, the lowest level we’ve seen since August.

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