The summer of market momentum continues. For passive investors, it’s the best of times: They’re seeing new highs on the two major cap-weighted indexes — S & P 500 and the Nasdaq Composite — with low volatility. It doesn’t get much better than that. For active investors, things haven’t been so great. These active investors want high volatility so they can quickly profit from their wagers. They want ” reversion to the mean ” trades, where outperforming sectors underperform, and laggards start rallying. Forget it. That’s not happening. Market volatility is near multiyear lows, and breadth (based on the number of advancing stocks versus decliners) has been flat to down for months. Tech — and the largest of these stocks in particular — is the winner this year, and everything else is bringing up the rear. You can see this in the odd dispersion of equal-weight sector exchange-traded funds, which give each stock in the sector an equal value. Equal weight S & P 500 sector ETFs YTD Technology up 14% Energy up 7% Utilities up 7% Financials up 7% Industrials up 4% Communication Services up 1.9% Health Care down 1% Consumer Discretionary down 1% Consumer Staples down 3% Bottom line: With the S & P 500 up 18% this year to a record high, only 102 names (or 20% of the index’s constituents) are actually up 18% or more. Only 58% of the stocks in the S & P 500 are up this year. The year of momentum With tech being the only big play, momentum players are having a field day. In its basic form, momentum is a simple strategy: You hold stocks that are on a winning streak. Many momentum strategies also sell stocks that are in a downtrend. It sounds simple, right? Except there’s a problem. Rebalancing is very tricky because mean reversion is a very real phenomenon in the stock market. Mean reversion is the assumption that a stock price will trend toward the average price over a long period of time. How long? That’s the game. No one knows how long a trend can last. This makes rebalancing — that is, changing the weightings — and reconstituting — or switching out stocks — a momentum portfolio very tricky. Of course, there are ETFs for that. The ETF industry long ago picked up on this strategy. One example is the Invesco S & P 500 Momentum ETF (SPMO) , which tracks the S & P 500 Momentum Index. That index follows the performance of stocks in the S & P 500 that have a high “momentum score.” Another is the iShares USA Momentum Factor (MTUM) , which tracks the MSCI USA Momentum SR Variant Index. Both of these funds have been big winners this year. Momentum ETFs in 2024 S & P 500 up 18.1% Invesco S & P Momentum ETF (SPMO) up 39.9% iShares USA Momentum Factor (MTUM) up 28.5% Both ETFs also have concentrated bets. In the case of SPMO, the top 10 holdings account for about 67% of the fund. Invesco S & P 500 Momentum ETF (SPMO) (top holdings) Nvidia 13% Apple 9.9% Microsoft 8.7% Meta Platforms 8.4% Amazon 7.6% Eli Lilly and Co. 5.3% Broadcom 5.6% Berkshire Hathaway 3.3% JPMorgan 2.3% Costco 2.2% Source: Invesco So far, it’s been a big winner because the top holdings have been consistent winners all year — and even before. It’s also attracted big inflows: There were 4.3 million shares outstanding at the start of 2024, now it’s up to 24 million shares. Why momentum is a risky strategy Let the buyer beware: Everyone looks like a genius holding on to winners in up markets. These funds can outperform in bull markets, but they can easily underperform in down markets. These funds also go through rebalancing. SPMO is reconstituted and rebalanced twice a year, in March and September, while MTUM is rebalanced in May and November. Rebalancing only twice a year can be a very long time in rapidly changing markets. It means the fund may be very slow catching up with changing trends. “In a rapidly changing market environment, the [momentum] strategies can be slow to catch-up meaning any hope of outperformance, especially in the short term, is most likely wishful thinking,” the website ETF Stream noted in a 2021 article on momentum ETFs.
Momentum rules the market this summer, but let the buyer beware
Jul 11, 2024
