Broader Market Rally and China’s Stimulus May Induce ‘Pain Trade’ for Cyclicals, According to Barclays

A potential “pain trade” may be on the horizon as cyclical stocks—those particularly sensitive to economic growth—could soon see a rally fueled by a combination of market expansion and recent stimulus measures from China, according to Barclays strategists.

In a recent analysis, the bank points out that the under-invested positioning of systematic funds and hedge funds in cyclical sectors could initiate a notable rotation as investors pursue gains.

Cyclical stocks, including automobiles, mining, and chemicals, have been significantly underrepresented in investment portfolios, especially those linked with the Chinese market.

With renewed investor interest in these stocks following China’s recent stimulus efforts, those maintaining a defensive stance may experience mounting pressure.

“China proxies such as autos, miners, and chemicals appear particularly under-owned, suggesting that further gains could qualify as a pain trade for many investors,” Barclays observes.

Strategists also emphasize that while equities face immediate risks from upcoming U.S. elections and a pause in buybacks prior to third-quarter earnings, macroeconomic factors like a soft landing for the U.S. economy and ongoing stimulus from China could attract additional capital into cyclical sectors. This influx might trigger a “fear of missing out” (FOMO) among investors with limited exposure to these assets, leading to a shift toward riskier investments.

Another essential element is the improvement in market breadth, with a growing number of stocks contributing to market gains. Barclays describes this broadening as “a healthy phenomenon,” indicating a shift away from concentrated leadership in defensive sectors.

As market breadth expands, the likelihood of a pain trade increases for those hesitant to adjust their investments.

The pain trade, according to Barclays, arises from the caution exercised by systematic strategies like commodity trading advisers (CTAs) and hedge funds throughout the year, even as equities have reached record highs. If market volatility remains low, these funds may be compelled to re-enter the market, driving up the prices of cyclical stocks.

“Sector positioning has leaned defensive in recent months, yet cyclicals have experienced some short-covering of late,” strategists remark.

Despite the potential challenges presented by the upcoming U.S. elections and short-term market obstacles, Barclays believes that ongoing macroeconomic support from both the Federal Reserve and China could facilitate this rotation into 2025.