Broader market rally, China’s stimulus may cause ‘pain trade’ for Cyclicals: Barclays

A potential “pain trade” could unfold as cyclical stocks—those highly sensitive to economic growth—may soon experience a rally driven by a mix of market broadening and China’s latest stimulus measures, Barclays strategists said.

In a Wednesday note, the bank suggests that the under-invested positioning of systematic funds and hedge funds in cyclical sectors could trigger a significant rotation as investors chase gains.

Cyclicals, including autos, miners, and chemicals, have been particularly under-owned, especially those with exposure to China.

With these stocks seeing renewed interest, particularly following China’s recent stimulus efforts, investors who remain defensively positioned could come under pressure.

“China proxies like Autos, Miners, Chemicals and our China exposure basket look particularly under-owned, so more upside would likely be a pain trade for most investors,” Barclays notes.

Strategists highlight that while equities face near-term risks such as the U.S. election cycle and a blackout in buybacks ahead of Q3 earnings, macro factors like a soft landing in the U.S. and China’s continued stimulus measures could drive more capital into cyclical sectors. This could prompt a "fear of missing out" (FOMO) among under-exposed investors, resulting in a market rotation toward riskier assets like cyclicals.

Another key factor is the improvement in market breadth, with a larger number of stocks contributing to the market’s upside. Barclays notes that this broadening is “a healthy phenomenon,” as it signals a move away from concentrated leadership in defensive sectors.

As market breadth widens, it further increases the likelihood of a pain trade for those slow to adjust their positions.

The pain trade, according to Barclays, stems from the fact that systematic strategies like CTAs and hedge funds have remained cautious throughout the year, even as equities have surged to record highs. Should market volatility stay low, these funds may be forced to re-enter, driving up cyclical stocks.

“Sector positioning has turned defensive over the past few months, but Cyclicals have seen some short-covering most recently,” strategists said.

Despite the risks posed by upcoming U.S. elections and near-term market headwinds, Barclays believes that continued macro support from both the Federal Reserve and China could sustain this rotation into 2025.

Source: Investing.com