While there’s a lot of talk about crowded trades right now, there’s precious little insight provided into what exactly constitutes a crowded trade and how it might impact you, the investor. What that in mind, Azzet went in search of some answers.
Firstly, like a lot of financial definitions, the term crowded trade can easily be overlooked, misunderstood and easily glossed over unless you understand its potential broader impacts on the market.
Remember, beyond the smaller end of the market, retail investors – mums and dads' trading stock- seldom move the markets on their own.
So when you hear the term crowded trade, it typically refers to institutional investors that have placed the same bets - buying or selling the same stock – at the same price and at the same time.
Given that an institutional investor cannot know how many other investors simultaneously enter the same trade, a trade could become ‘crowded’ without them even knowing it.
Crowdedness can be measured by the total value of active institutional positioning in an asset relative to its trading volume and typically occurs when the number of investors chasing a similar strategy is too large given the available liquidity or typical turnover.
What’s wrong with this you ask?
Trouble is, these crowded trades often attract so much participation that they create imbalances in price and risk to the downside, and we’re seeing shades of this in the U.S with the big money currently chasing technology and AI themes.
The net effect is that none of these entities that took exactly the same trades can exit without having a material impact on the price, which for you, the shareholder, isn’t great.
It’s the concentration of ownership created by crowded trades that impacts a stock’s returns.
The risk of crowding has increased in the past decades due to the growing share of institutional investors in the market, particularly the activity of hedge funds.
It’s the liquidations of crowded positions that can trigger price distortions, and in some cases, the ‘crowded effect’ can result in prices being pushed further away from fundamentals.
What’s happening now?
Based on Citigroup’s latest review of global market positioning, investor sentiment varies significantly across different regions and sectors.
For example, communication services and technology sectors are among the most crowded in the United States and Asia, excluding Japan, while energy and financials dominate in Europe and Japan.
Here in Australia, the technology sector is currently the most crowded trade, while financials lead crowding in Europe on an equal-weighted basis.
When it comes to other sectors in Australia, consumer discretionary has fallen to third place in terms of crowding.
Communication services have surged from the second least crowded to the fourth most crowded sector.
Meanwhile, health care and energy have declined towards the bottom of the pack, according to Citigroup’s analysis.
Magnificent Seven’ stocks
Within the ‘Magnificent Seven’ stocks, Amazon’s short crowding score remains near the universe average.
Apple experienced the largest increase in long crowding and the largest decrease in short crowding scores over the past one and four weeks.
Nvidia’s crowding score is unchanged over the past week and remains a highly crowded long.
According to BofA's monthly fund manager survey, owning big U.S. tech stocks is once again the most popular trade, as upbeat earnings and improved sentiment towards the global economy send investors back into stocks.
Almost half (45%) of the 169 participants in August's survey, who have US$413 billion in assets under management, said they thought the most crowded trade was “long Magnificent 7”.
Strong earnings have helped big tech stocks to bounce back sharply since their tariff-induced selloff in April.
They were last seen as the most crowded trade in March, the survey suggests.
Broad investor sentiment improved in August, with around 5% of asset managers positioning for a hard landing, characterised by a sharp slowdown in economic growth.
A net 14% of those surveyed were overweight global equities, the highest since February, though still down sharply from net 49% overweight in December.
