Now half the stock market is a crowded trade as FANG riches thin

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You may think the rotation away from technology megacaps has made the stock market a safer place. New research says you'd be wrong.

All year, a major bear case on equities has held that too many investors had too similar a take on the FANG group – dumbfounded bullishness – and once sentiment turned, the whole market would crater. But now it's turned, and the market is fine. All clear, right?

According to a study by Sanford C. Bernstein, not so fast. The New York-based brokerage has a statistical model for assessing when fund-manager sentiment is harmonizing toward a given sector, a quality it calls crowding. Disturbingly, the model sees evidence that last month's rotation has done little to squelch the FANG adoration – and that a similar level of obsession is spreading to other groups such as utilities and industrials.

In fact, broken down by sectors, almost half of the market is evincing signs of institutional groupthink relative to levels in the past. That's a departure from the first eight months of the year, when the concentration risk sat solely with tech. While crowding itself isn't a catalyst for turbulence, the firm says, too much love means the threshold for disappointment is low.

"I wouldn't interpret this call as saying the market is about to tank," Ann Larson, a quantitative analyst at Bernstein, said by phone. "People are changing their positioning, but they're all going in the same direction. For these stocks and sectors, that presents a risk. And the crowding environment is getting more extreme."

But wait, how can half the global stock market end up being a crowded trade? After all, every share of stock is owned by someone, for every buyer there's a seller, and fund managers can only burrow into so many trades. Isn't it a little weird to grade company popularity based on things other than price?

While "all stocks are owned by someone," Ms. Larson says, "the risk comes from the ownership mix, since certain types of owners are more likely to stampede for the door than others. Our model is designed to separate speculative owners and fast money from long-term holders."

In Bernstein's study, a stock gets more crowded when a rising number of institutional owners have it as one of their 20 biggest holdings versus benchmarks. Crowdedness also goes up if institutions are net buyers over several straight quarters, or if there are a lot of buy ratings, or even if earnings estimates have gone up rapidly over a period of years. Price momentum is also a factor.

Using that standard, material producers have surpassed technology as the most crowded group relative to their own history, with European energy stocks also joining the ranks. While the rotation out of high-flying tech names is seen by many as something helping broaden stock participation, the growing list of stocks with these characteristics shows the congestion not only hasn't been cured, but is getting worse.

Investors need to look no further than this year's tech volatility to get a glimpse of what might happen should all the money start exiting at the same time. In June, Nasdaq 100 shares gave up $400-billion (U.S.) in a series of rapid-fire sell-offs, sending volatility in computer and software shares to the highest since 2008 versus the rest of the market. Stocks with the highest price momentum bore the brunt of the downdraft, a sign of unwinding among quantitative funds.

While the latest tech wreck did zero damage to the overall market, investors saw the unwinding of popular trades in biotech and small-cap stocks cascading into a bigger sell-off in August, 2015, when the S&P 500 suffered the worst slump in four years.

Ms. Larson attributes most of the recent market congestion to investors rushing to cyclical shares in anticipation of higher inflation and interest rates. Their ascent is occurring at the expense of consumer stocks, the firm's study found.

"Crowded stocks are the good stocks that people like for a reason," she said. 'They tend to react much more negatively to bad news, but less positively to good news because they're priced for perfection. Eventually even a small piece of negative news can drag it down."

Below are other findings from Bernstein on the trend of crowding in stocks:

• Europe ex-U.K. is now the most crowded region, while the United States and Britain are currently at “very low” crowding levels relative to their own history;
• Among sectors, health-care and telecom companies are the least crowded;
• Some stocks that joined the list of most crowded: Total SA, Glencore PLC, Credit Agricole SA, Sherwin-Williams Co. and Renault SA;
• Among stocks that were dropped: Iberdrola SA, Motorola Solutions Inc., Mohawk Industries Inc. and Newell Brands Inc.