Be Wary of Widely Held Stocks: Apple, Google, Amazon

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Some of the most popular investments could also be among the most vulnerable to the downside if overall market sentiment turns negative. This doesn’t necessarily have anything to do with the fundamentals of these companies. Rather, it has to do with the way in which mutual funds and hedge funds operate.

When the market turns lower, investors begin to get concerned that the market will fall even further. This in turn leads them to sell their stakes not just in individual stocks but in mutual funds and in hedge funds, as well.

When mutual funds and hedge funds get redemption requests they must honor them, with the exception being hedge funds that lock up your money for an agreed-upon amount of time. When these funds begin to get redemption requests, they have to sell some of their holdings, even if they like the fundamental story.

Which stocks are managers most likely to sell? The two categories that come to mind are stocks that comprise their largest holdings and stocks that have performed the best in the recent past. Investors should keep in mind that for many fund managers, these are the same stocks. If a stock rises more so than others, then it becomes a larger portion of any given portfolio.

Furthermore, investors in mutual funds and hedge funds like to see that their managers are buying a lot of the stocks that are going up the most. This means that managers are more likely to take fund inflows and buy more shares in the companies that have been performing well.

In a rising market, this means that the best-performing stocks tend to draw more attention, which in turn drives them even higher. This means that the funds that bought shares in these stocks early are going to show the best performances, and the best-performing funds draw the most inflows; this puts even more buying pressure on these top-performing stocks.

This is what sent shares of companies like Apple (NASDAQ:AAPL), Google (NASDAQ:GOOG), and Amazon (NASDAQ:AMZN) ever higher.

While this is great for fund managers and investors in these funds, as prices rise, this effect only serves to hit these stocks harder when the market turns.

Even if, for example, Google is fundamentally fairly or undervalued, the fact that so many fund managers own it (it was the most widely held stock among mutual funds in the fourth quarter), it is vulnerable to the downside. Lots of fund managers have made a lot of money in Google stock. This has improved their overall performances, and this in turn attracted more money, which the fund managers allocated toward Google.

But now, with the market falling, we can start to see investors pull their money out of mutual funds. As a result, these fund managers could be forced to sell Google shares even if they don’t want to. This negative price action can generate negativity among investors — even if it is unwarranted — and this can lead to even more selling.

This is bad news if you own a stock such as Google, but it is great news if you are looking to buy Google stock. Disciplined investors who are aware of this phenomenon can hold off on buying a stock even if they think it offers good value because they are aware that they can likely get it at a better price. While waiting for better value even if you believe in the fundamentals of a particular investment can try your patience, doing so can be extremely rewarding.

Ultimately, if you think that we are about to see a market correction, you should hold off on buying stocks that are widely held. The most widely held stock in hedge funds is Apple, and the most widely held by mutual funds is Google. Microsoft (NASDAQ:MSFT) and Facebook (NASDAQ:FB) were also near the top of the list in the fourth quarter. While there may be fundamental value of these stocks, now probably isn’t a good time to be buying them — you want to wait for fund managers to sell them. This could create incredible buying opportunities in some high-quality stocks, especially if negative momentum begets additional negative momentum.

Disclosure: Ben Kramer-Miller has no positions in the stocks mentioned in this article.

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