U.S. equities could be in for another rout after a rally earlier this summer gave investors some breathing room.
At least that’s what strategists at RBC say is indicated by tracking their firm's "Hedge Fund Hot Dogs."
The "Hot Dogs" represent a basket of stocks in the S&P 500 with the highest allocations of hedge fund dollars based on holdings of 300 major firms.
Since the bank began tracking this group in 2018, RBC found that when the “Hot Dogs” underperformed the broader markets, a sell-off in stocks tended to follow suit.
Inversely, when this basket has outperformed the broader market, the indexes have usually risen in kind. In May and June of this year, for instance, a summer rally began shortly after top hedge fund holdings began outperforming a slumping sock market.
“In late May and June of 2022, some outperformance of this basket started to emerge again, making us optimistic that the mid-June low in the S&P 500 may end up being the bottom in the current cycle,” RBC analysts led by Head of U.S. Equity Strategy Lori Calvasina said in a report.
But RBC warned that in the third quarter so far, only one quarter of names in this list outperformed the broader benchmark index.
“This is something we are keeping a close eye on as it may be signaling that stocks generally are poised to experience another bout of volatility in coming months,” RBC said.
U.S. stocks fell sharply Friday after Federal Reserve Chair Jerome Powell delivered hawkish remarks at the central bank’s symposium in Jackson Hole, Wyoming. All three major averages plunged immediately following his speech, with the S&P 500 and Dow Jones Industrial Average each poised for their worst session since June.
Lazard Asset Management Head of U.S. Equity Ron Temple said Friday in a note that investors continue to underestimate the duration of monetary tightening ahead and the structural implications of inflation that Fed policy cannot change.
“It’s time for investors to reassess their expectations of discount rates and recession risk, both of which have been too optimistic of late,” Temple said.
A rally earlier this summer stoked optimism among bulls that the worst of this year’s downturn is over. The S&P 500 gained more than 17% between mid-June and mid-August, per Bloomberg data, while the technology-heavy Nasdaq composite officially entered a new bull market during the same period at a gain of more than 23%.
But the rally has since lost steam, with Powell’s speech in Jackson hole affirming to investors that a pivot in policy is far off and officials are willing to endure job losses and economic slowdown to restore price stability.
“Even with [Friday's] drop in the stock market, we are nowhere near down 20% year-to-date in the S&P 500,” Chris Zaccarelli, chief investment officer of Independent Advisor Alliance said in a note Friday.
"So either we have much farther to go on the downside, or the market will continue to trade in defiance of what the Fed is trying to tell it."
Alexandra Semenova is a reporter for Yahoo Finance. Follow her on Twitter @alexandraandnyc