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Momentum Is Rising From the Dead, But Only for Equity Quants

It's not just about market leadership. It’s also about which stocks aren’t going up.

by Dani Burger (Bloomberg)

Call off the search party. Stock market momentum has been located.

As investors chasing trends across asset classes have gotten pummeled over the past few weeks, a smaller subset of asset managers has managed to thrive: market-neutral momentum equity funds. The vehicles employ a quantitative strategy where the market’s greater moves are hedged out, isolating bets around stocks that have gone up the most in the past year.

Momentum in the market is tied to technology stocks, which meant a rocky few days last month when the Nasdaq 100 Index sold off. But now the momentum trade has re-emerged with full force. Even as the S&P 500 Index has fallen 0.3 percent since the July 4 holiday, market-neutral momentum has posted its best four-day run since before Brexit, according to Bloomberg PORT.

For some analysts, the trade was always bound to recover after that momentary blip in June, which some hypothesized was due to a rogue quant fund unwinding its momentum positions. At BlackRock Inc., such downdrafts are nothing more than a buying opportunity for a strategy prone to short-lived reversals, according Richard Turnill.

“Today’s low volatility environment coupled with a sustained economic expansion bode well for momentum,” BlackRock’s global chief investment strategist wrote Tuesday in the firm’s mid-year outlook. “A sharp drop in tech stocks in mid-June illustrated the risks of momentum breaks.”

Besides equities, strong and consistent market trends have been hard to come by this year. Commodity trading advisers -- funds which typically bet on price trends through futures contracts -- are heading for their worst year ever thanks to choppy movements in currencies and fixed income.

Short Leg
But the momentum trend in equities appears to have resumed. Take the two top performing S&P 500 stocks over the past 12 months: Advanced Micro Devices Inc. and Nvidia Corp. They’re also the two biggest gainers over the past five days, advancing 15 and 11 percent, respectively.

“We’re starting to see momentum and leadership strategies stabilize,”  Satya Pradhuman, director of research at Cirrus Research LLC, said during a quarterly outlook conference call. “It should continue to work well.”

However, the resurgence of the momentum trade isn’t just about market leadership. It’s also about which stocks aren’t going up. Indeed, without the short leg of the bet, momentum would not have done as well, according to Joseph Mezrich, head of U.S. quantitative analysis at Nomura Instinet LLC.

“It has mainly been on the short side: about 5 percent from shorting past losers and 2 percent from buying past winners,” said Mezrich. “There was quite a bit of short side volatility since the tech drawdown episode of June.”

For example, Under Armour Inc., the biggest loser in the S&P 500 over the past 12 months, dropped 9.3 percent in the past five days. Macy’s Inc., which has fallen 11 percent since July 3, is also among the worst performers both in the past year and past five days.

Nowhere was the success of shorting weak stocks more apparent than in long-only smart beta exchange-traded funds. For example, the long-only iShares Edge MSCI USA Momentum Factor ETF has gained 1.7 percent since July 3, topping the S&P 500, but it came up short when compared with the 3.2 percent return of the long-short Dow Jones U.S. Thematic Market Neutral Momentum Index over the same time frame.

“We see room for the momentum style factor and the technology sector to outperform further,” Turnill wrote. “Momentum has historically outrun the broader market, but with periodic sharp drops.”

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