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What Happened to Momentum Stocks? 

Klaus Teloeken 



Despite the recent and broad-based underperformance in momentum stocks, Co-CIO Systematic Equity Klaus Teloeken says there are no clear underlying fundamental causes, so there’s no need to expect these names will suffer for long.
Since the beginning of March, there has been a substantial change in market favourites. Many of the favourites of the last four quarters – such as US tech and biotech stocks – have sold off, while former laggards have started to bounce back. Interestingly enough, this momentum reversal happened without a significant index-level change or an obvious fundamental catalyst.

Stocks with the highest momentum have underperformed since early March, primarily in the first two weeks of April, and have not recovered through at least late May. The falloff in momentum stocks has been broad-based, occurring in all regions and particularly in Europe. This underperformance happened in 80 per cent of all sectors, with US biotech and IT stocks at the epicenter. All told, the outperformance of momentum strategies that accrued over the last four months in the US and the last eight months in Europe has been erased.

To put this into perspective, global momentum strategies have suffered worse performance in only 8 per cent of the months since 1987. Yet while the latest momentum reversal has been meaningfully strong, it is still far from being as extreme as these familiar events:

October 1998, after the near collapse of LTCM¹
Spring 2000, when the TMT bubble burst
Spring 2003, when the bear market following the TMT² bubble ended
Autumn 2008, in the midst of the Great Financial Crisis
Spring 2009, when the bear market following the Great Financial Crisis ended

Generally, momentum stocks exhibit a seasonal pattern and typically revert to the mean in January. What happened in April was of the magnitude of a strong mean-reversion trade, but nothing more than that.

As a result, we believe this momentum-stock underperformance is by no means extreme; it still looks like the kind of relatively normal momentum reversal that happens every now and then, particularly in January. Truly dramatic episodes of momentum-strategy underperformance normally only happen in strong market turnarounds – something we don’t envisage being the case here.

There seems to have been no obvious macro-related cause for the reversal trade.

If it were simply a risk-off trade triggered by events in the Ukraine or concerns about the pace of global growth, then higher-risk segments of the equity market would have done worse.
If it were driven just by concerns about rising US rates following the mid-March hawkish speech of US Fed Chair Janet Yellen, then again, emerging markets would have done worse.

Of course, this is not to say that the recent momentum reversal is entirely unrelated to these events. After all, momentum stocks are pro-risk and cyclical at the moment, and are generally less effective in times of rising rates. But no particular aspect of these events offers an explanation for the sharpness and suddenness of the recent momentum reversal, or gives a reason to expect these moves to persist.

And this is even more true when considering that momentum stocks are by no means unattractive even after the shift: From a bottom-up perspective, momentum stocks are inexpensive on most valuation measures, and on a price-to-earnings (P/E) basis, momentum stocks are outright cheap. Moreover, momentum stocks are supported by above-average earnings revisions.

From a top-down perspective, momentum stocks typically outperform during the middle of the cycle, and while momentum stocks are generally less effective when rates are on the rise, momentum stocks can still continue to perform in times of rising rates.
From a bottom-up perspective, momentum stocks are inexpensive on most valuation measures, and on a P/E basis, momentum stocks are outright cheap. Moreover, momentum stocks are supported by above-average earnings revisions.

From this, we conclude that the performance of momentum stocks has been weak, but clearly not exceptionally weak; it still looks like a relatively normal, albeit stronger momentum reversal. We find no really convincing reasons to support the argument that momentum stocks are set for a protracted period of underperformance.

1 Long-Term Capital Management
2 Technology, media, telecommunications

The material contains the current opinions of the author, which are subject to change without notice. Statements concerning financial market trends are based on current market conditions, which will fluctuate. References to specific securities and issuers are for illustrative purposes only and are not intended to be, and should not be interpreted as, recommendations to purchase or sell such securities. Forecasts and estimates have certain inherent limitations, and are not intended to be relied upon as advice or interpreted as a recommendation.



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