The 'Most Crowded' Trade in the World Today

The 'most crowded' trade in the world today... A warning from the global fund manager survey... Even bond investors are jumping into high-flying tech companies now...

Yesterday, we noted that a handful of high-flying tech stocks have accounted for the bulk of the gains in the major U.S. indexes this year...

The so-called "FAANG" stocks – Facebook (FB), Amazon (AMZN), Apple (AAPL), Netflix (NFLX), and Alphabet (GOOGL) – along with software giant Microsoft (MSFT) have accounted for a remarkable 98% and 105% of the gains in the S&P 500 and Nasdaq 100, respectively, according to data from financial-news network CNBC.

So it's little wonder these stocks are also incredibly popular among investors today. In fact, according to the latest Bank of America Merrill Lynch Global Fund Manager Survey ("FMS"), these stocks are the "most crowded" trade in the world for the sixth straight month.

The FMS is exactly what it sounds like... Each month, the firm surveys more than 200 money managers – with more than $600 billion in combined assets under management ("AUM") – from all around the world to see how they're generally investing, and what they're thinking about the markets.

Among the various questions is one asking managers to rate what they believe is the single most crowded or popular trade among investors. And again, the hands-down choice of late has been the "long FAANG" trade.

Now, longtime readers know we're contrarian at heart...

Whenever "the crowd" is betting the same way in the markets, our inclination is to take the other side of that bet.

But we generally give much more weight to substantive data about what investors are actually doing with their money – such as the weekly Commitments of Traders report we follow – rather than a subjective survey like this. In fact, you could argue that what most fund managers are thinking could itself be a contrarian indicator in many cases.

However, we must admit that it has this particular indicator has been remarkably prescient over the past several years.

For example, back in February 2015, more than 70% of global fund managers believed "long U.S. dollar" was the most crowded trade in the world. The U.S. Dollar Index peaked the next month, and went on to lose more than 7% over the next five months.

The next time most managers agreed was December 2015, where they once again named long dollar the most crowded trade. The Dollar Index peaked that same month and lost around 8% over the next six months.

The next occurrence was January 2017, where fund managers again singled out the U.S. dollar as the world's most popular trade. As you can see in the chart below, this time the dollar collapsed nearly 15% over the next year, a huge move for a major currency...

This month marks the first time a clear majority of managers agree in more than a year and a half...

Managers did name "long bitcoin" as most crowded last December, and "short volatility" as most crowded in February, which were great calls as well. But each of these received less than 35% agreement.

Today, more than 50% of global fund managers believe the long trade in tech stocks is dangerously crowded. If recent history is any indication, these stocks could struggle in the months ahead.

Of course, this signal doesn't mean these stocks can't continue to lead the market higher. (And as always, we don't suggest making investment decisions based on a single indicator alone.)

But it does suggest that this trade is ripe for at least a short-term reversal, and any hiccups in these stocks – such as the earnings "miss" from Netflix on Monday – could trigger a swift sell-off.

The love affair with these tech giants isn't limited to stock market investors, however...

Apparently, even traditionally more conservative fixed-income investors have been getting in on the action, too. As Bloomberg reported this morning...

Meet FANG, in structured-note form. Holders of these securities – complex bonds tied to the performance of Facebook, Amazon.com, Netflix, and Google parent Alphabet – typically forgo the prospect of stratospheric upside. In return, they can weather as much as a halving in the cohort's equity value, and along the way may accrue double-digit coupons and eventually their principal.

The popularity of these products is mounting. Investment banks have sold nearly $60 million of FANG-linked notes this year, up from $45 million over the same period in 2017, according to data compiled by Bloomberg, many of which are structured with such downside protection...

The notes are in effect an exotic-derivatives strategy that involves selling down-and-in put options, a trade typically restricted to the most sophisticated investors. Holders face call and counterparty risk, thin liquidity compared with the underlying shares, and give up their right to collect dividends.

In simple terms, these "bonds" will pay out double-digit annual yields of as much as 17%... so long as none of the underlying stocks fall more than roughly 40% from today's prices over the next three years. If they do, folks holding these instruments would no longer be paid interest... and could lose their initial investment or "principal," as well. More from the report...

The chance that either Facebook, Amazon, or Alphabet will fall by 40% by January 2020 is 3% or less, according to delta-implied probabilities from put options. Netflix is seen as the most vulnerable at about 5%, according to data compiled by Bloomberg. That doesn't take into account the chances that any one of the four stocks could fall by this amount, which is higher than any of the individual probabilities.

We aren't predicting a crash of that magnitude in these market leaders today...

But we also acknowledge that it's not out of the question... and the risk could be significantly higher than the market believes today.

After all, even if our colleague Steve Sjuggerud is correct and the "Melt Up" runs for another year or two, these bonds aren't necessarily out of the woods. A serious bear market could begin long before they mature... and history shows bull market darlings like these could suffer huge declines when it does.

New 52-week highs (as of 7/17/18): Amazon (AMZN), Becton Dickinson (BDX), CBRE Group (CBRE), First Trust Nasdaq Cybersecurity Fund (CIBR), Facebook (FB), Fidelity Medical Equipment Fund (FSMEX), Alphabet (GOOGL), ETFMG Prime Mobile Payments Fund (IPAY), Microsoft (MSFT), ProShares Ultra Technology Fund (ROM), Sysco (SYY), and Verisign (VRSN).

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