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Rather than focusing on valuation or fundamentals, momentum strategies use price behavior and relative performance to identify securities that are gaining or losing strength. One would think that, given the massive rotation trade and the resulting gaps in relative performance between various sectors and factors, momentum strategies would be doing well. While some such strategies are doing very well, others aren’t.
A flaw in some momentum strategies is that their signals can react slowly; they enter trends late in a rotation cycle, after much of the move has already occurred. Further compounding the problem, they may also exit only after losses have begun. These lags can cause investors to chase crowded trades near peaks and suffer reversals when market leadership rotates quickly.
To illustrate the flaw in some momentum strategies, we share findings from SimpleVisor. SimpleVisor uses the iShares USA Momentum Factor ETF (NYSE:MTUM) to assess the relative and absolute technical standing of momentum strategies.
The left graphic shows the excess returns (relative to the S&P 500) of the factors over the last 30 trading days. Two-thirds of the factors have handily beaten the market, while large-cap growth stocks have lagged. The red rectangle shows that the MTUM ETF has kept pace with the market.
The graphic on the right shows that MTUM is at fair value, while value is very overbought and growth is decently oversold. MTUM is slowly shifting from growth to value, but as we share, it’s late to the game. Might it be shifting toward value and away from growth just as the market is about rotate back toward growth?
Momentum strategies work in long-lasting trending markets. But in markets with quick, pronounced rotations, or even in the early phase of a longer-lasting trend, they can be flawed, as we see.
Buy Reflation Sell Growth
As we share below, the rotation toward economically sensitive sectors and toward value-oriented or conservative stocks, and away from technology and growth, has become severe. The bifurcation of returns is likely to normalize in the coming days or weeks. The question is what will get investors to change their behavior to allow for a more normal distribution of returns across sectors and factors.
We think there are two potential factors. First, the reflation trade fails to deliver. Last week’s CPI was lower than expected, and other price indicators suggest lower price growth in the coming months. It’s hard to believe the economy is taking off, yet inflation is falling. Moreover, excluding the recent BLS employment report, all other labor indicators point to continued weakness. Again, such doesn’t jibe with a reflationary narrative.
Second is Nvidia (NASDAQ:NVDA). Their earnings report, a week from today, could rejuvenate the technology and growth bulls. They are likely to exceed earnings expectations and once again increase their growth forecasts. Given that many stocks in the sector, especially software companies, are trading poorly, a rotation back to growth from value may kick off with their earnings next Wednesday.
Bear in mind that while we expect a rotation toward growth, we are unsure whether it will be temporary or longer lasting. Our technical indicators and analysis will help us cross that bridge when the day comes.
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