The Dangers of the Crowded Trade

 | Mar 26, 2012 | 12:30 PM EDT  | Comments
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Stock quotes in this article:

crm

,

aro

It was a busy weekend around here as always. In addition to introducing my daughter to Hunter Thompson's body of work (I may have cause to regret this (oh yes -- ed)), discussing the probable need for martial law in the state of Kentucky next week as two instate rivals meet in the Final Four, we seasoned the grill for summer by smothering in steaks and talked about the stock market.

The big question on everyone's mind seems to be if the fantastic rally we have had this year is nearing an end. We had a down week last week and that has been as rare as Orioles in the playoffs. Is the end near or will the power of ZIRP and LTRO reassert itself and drive prices higher?

My answer as always is that I have no clear idea what the market will do this week or if it closes higher or lower over the next month. There is no worse short-term market timer than I. It is not what I do and if I had to focus on this I would be forced to steal Jim Cramer's bottle of cheap Scotch and curl up under the kitchen table. The few technical indicators I use tell me the market is on the high side of things and probably overbought. Experience teaches me that although the caution flag may be waving, stocks can stay on the high side far longer than one would anticipate especially in a period of aggressive monetary policy. Most of my friends are more trading oriented than I and the suggestion that holding what you have and being cautious about new purchases can lead them near madness at times.

When pushed, I proffered an idea of what I would not to do right now in the stock market. Unless you are the world's greatest short-term trader I would not own any of those stocks heavily owned by institutions. When the music stops playing, the chairs disappear quickly in the stock market and if you are caught long stocks as the funds are dumping you are going to feel some serious pain. The market and most participants are complacently bullish right now with volatility at low levels. If that changes and the Streets risk models start screaming sell, history tells us that they can dump stocks faster than you can exit your positions.

I ran a screen this morning to see which stocks are the most heavily owned and might be wise to avoid right now. One that stands out for me is Salesforce.com (CRM). Not only is the stock richly valued at 75x the always highly accurate analysts' forecast, the stock has shot up more than 50% so far this year. And 99% of the shares of this company are owned by institutions. Obviously they have a great business as bad companies do not have these types of multiples or attract this level of interest. But if they stumble and miss estimates or the stock market begins to crack the exit door will crowded quickly. If you look at the chart and see what happens when the risk-off lamp is lighted, you get an idea of the real risk of owning these shares here. It can go down even faster than it has soared if sellers begin to dominate the trade in the stock.

Aeropsotale (ARO) is another stock that has had a great run so far this year. The stock is up 38% and has more than doubled in the last six months. The return of the consumer has given the company and lift and they are benefiting from the recent decline in cotton prices as well. A lot has gone right for the company and they have several brokerage upgrades in recent weeks. Institutions have taken noticed and have been aggressive buyers of the stock. They may love it too much as they now own 97% of the outstanding shares of the company. Once again, when you look at the chart you can see when the risk-off lights are on this stock has experienced sharp moves to the downside. It might be prudent to hold off buying this stock at current levels.

I do not make market predictions. I will suggest that, given the low levels of volatility following a strong rally, it makes sense to check the institutional levels of ownership in stock you own or are considering to make sure you are not in a crowded trade.

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