Broader market rally, China stimulus could cause ‘painful trade’ for Cyclicals: Barclays By Investing.com

A potential “pain trade” could be unfolding as cyclical stocks – those highly sensitive to economic growth – could soon experience a rally driven by a combination of market expansion and China’s latest stimulus measures, have said Barclays strategists.

In a note on Wednesday, the bank suggested that the underinvested 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, were notably under-held, particularly 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 such as Automobiles, Miners, Chemicals and our China exposure basket look particularly underowned, so more upside would likely be a painful trade for most investors,” notes Barclays.

Strategists point out that while stocks face near-term risks such as the US election cycle and a pause in buybacks ahead of Q3 earnings, macro factors such as a soft landing in the US and continued stimulus measures by China could drive more capital into cyclical sectors. This could cause a “fear of missing out” (FOMO) among underexposed investors, leading to a market rotation towards riskier assets such as cyclicals.

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

As the market width widens, the likelihood of a painful trade for those who stop adjusting their positions increases even more.

According to Barclays, the painful trade stems from the fact that systematic strategies such as CTAs and hedge funds remained cautious throughout the year, even as stocks rose to record highs. If market volatility remains low, these funds could be forced back in, driving cyclical stocks higher.

“Sector positioning has turned defensive in recent months, but Cyclicals have seen short covering most recently,” strategists said.

Despite the risks posed by the upcoming US election and near-term market headwinds, Barclays believes continued macro support from the Federal Reserve and China could support this rotation through 2025.