In the past few days there’s been an interesting divergence happening in equity markets. Multiple high-growth small cap names have lagged, while low-multiple low growth large cap names have done relatively better. Yesterday, some very high profile momentum names like Tesla Motors Inc (NASDAQ:TSLA), Facebook Inc (NASDAQ:FB) and Netflix Inc (NASDAQ:NFLX) were down a lot. Meanwhile, stocks like Apple Inc (NASDAQ:AAPL), International Business Machines (NYSE:IBM) and AT&T Inc (NYSE:T) were leading.
These are two very different groups of stocks that are owned by very different types of investors. The first group tends to attract aggressive faster money types, the second tends to attract more “steady-as-she-goes” personalities.
Three days is not enough to confirm that there is a shift happening, but if market leadership is turning from momentum towards value, it’s an important change. Both bulls and bears could probably each claim this as a good omen for their particular camp.
Argument for the bulls:
Momentum stocks had a great run and reached unsustainably high valuations. It’s healthy for the market that these stocks are pulling back. This is a simple change in leadership and reflects the fact that investors who have been on the sidelines are refreshed and ready to re-enter the market by purchasing high-quality companies which still trade at relatively low multiples. The Fed remains dovish and will continue to depress interest rates, which means that even though valuations are historically high they can climb higher, because equities still provide the potential for superior returns compared to fixed income.
Argument for the bears:
Momentum stocks’ collapse is a signal that irrational buyers have run out of money to support unreasonable valuations. This is the first stage of the risk pendulum swinging from positivity to negativity. Momentum stocks’ weakness will begin to snowball into broader market weakness as complacency turns to fear that spreads to other segments. The outperformance of low multiple stocks is a sign that big money is trying to position itself more defensively in anticipation of a longer term decline.
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