As the markets progress through a tumultuous earnings season, one chart jumps out as illustrating a key narrative. The momentum trade has worked for a while, but now it appears to be the only thing that is working.
Here we have a PerfChart of some of the iShares factor ETFs: Momentum (MTUM), Quality (QUAL), Low Volatility (USMV), Size (SIZE), and Value (VLUE). Each line shows the relevant ETF and its year-to-date performance relative to the S&P 500.
You’ll notice that four of the ETFs have underperformed the S&P 500 in 2018, with value down the most (around 3.5%). Momentum, however, has outperformed by over 5% during that same period.
What is momentum actually trying to capture? Essentially, this ETF is providing exposure to the momentum factor, which is a well-known phenomenon where stocks that have performed well over the previous 6-12 months tend to continue to perform well.
When you look under the hood, you can see why this ETF has performed so well. The top holdings include Amazon, Microsoft, Visa, Boeing, and Netflix. This is basically a vehicle to gain exposure to the FANG trade, or what I have termed the MANIA trade.
Here’s the same chart from the end of 2016. MTUM is up almost 24% relative to the S&P 500, while all the other factor ETFs have underperformed.
Now we understand the degree to which momentum has driven the market higher. As the momentum trade has continued to work, institutional investors have faced huge career risk by not owning these names!
It’s important to note that while momentum has worked over the long term, there are plenty of periods where it has been a losing strategy. For example, in the first seven months of 2016, we saw the low volatility trade dominate while momentum was actually flat relative during the period.
This chart of factor ETF returns is one of the things I’ll be watching to see if the momentum factor begins to falter relative to others. When that starts to occur, it could be the sign of further downside for equities.
David Keller, CMT
President Sierra Alpha Research LLC
David Keller, CMT is President of Sierra Alpha Research LLC, a boutique investment research firm focused on managing risk through market awareness. He is a Past President of the Chartered Market Technicians Association and most recently served as a Subject Matter Expert for Behavioral Finance. David was formerly a Managing Director of Research at Fidelity Investments in Boston as well as a technical analysis specialist for Bloomberg in New York. You can follow his thinking at marketmisbehavior.com.
Disclaimer: This blog is for educational purposes only and should not be construed as financial advice. The ideas and strategies should never be used without first assessing your own personal and financial situation, or without consulting a financial professional.
The author does not have a position in mentioned securities at the time of publication. Any opinions expressed herein are solely those of the author, and do not in any way represent the views or opinions of any other person or entity.