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Edward Cole is Head of Multi-Strategy Equities at Man Group.
In physics, the more momentum an object has, the harder it is to stop. We have now seen several periods where the momentum factor seemed to be running out of steam, only to pick up again.
But “Momo” is now on such a tear that it seems it's time to declare that bounce means a thing of the past and be done with it.
As a reminder, momentum is an investment factor or strategy that seeks to exploit the fact that stocks that have performed well in the past tend to perform well in the future, at least to some extent. One of the things about momentum is that it works very well. . . So that doesn't happen.
Setbacks – when they come – can hit hard. In 2009, there was a 73 percent drawdown in the factor. In 1932, it fell by more than 90 percent. Smaller but painful momentum reversals occurred in the wake of the dot-com boom and again in November 2022.
As the Financial Times Alphaville reported, hedge fund strategies – in their long books at least – are currently more concentrated in the momentum factor than at any other time in history.
Intuitively, this makes sense. In fact, you can see the rise in momentum as a natural result of the concentration we can currently see in US stocks – a wave of money chasing the same handful of tech winners, and the fact that long beta has done remarkably well over the past 18 months or So. It's worth noting that the recent fluctuations in the factor were driven by a temporary break in Nvidia's inexorable rise.
So, are we currently seeing a momentum bubble? Should we expect a reversal?
The first thing to say is that until the recent AI-induced rally, momentum was actually having a very disappointing time as a factor. Momentum depends on continued leadership – the winners keep winning – and the second half of the 2000s and the first few years of the 2010s have seen a number of challenges to leadership, with a combination of geopolitics, coronavirus and inflation fears leading to… to poor performance. Few years for this factor.
So, short of entering bubble territory, momentum may have a fair way to go. If you want to see what momentum looks like during a real bubble, take a look at the lead-up to the dot-com bust, or the global financial crisis. It is clear to us that although we have seen a significant increase in factor compared to recent levels, we are far from the one-way traffic we experienced during those periods of irrational exuberance.
If we look back at the history of this factor, we can see that the kind of fluctuations momentum saw in late 2010 are the exception rather than the rule. Momentum enjoyed long periods of multi-year outperformance in the 1960s and again in the 1980s.
It is worth thinking about what links these periods: strong growth in nominal GDP driven by rising consumer spending and a housing boom; They saw moderate but not persistently low inflation; They saw increased participation in stock markets; They saw technological innovations that dramatically changed the fabric of everyday life.
It's not hard to think – well, maybe with a certain level of pink tint – that the coming years might hold something similar. If you believe the economic picture over the coming years is positive – a soft landing or no landing scenario – you might expect the upward trend of momentum to continue, perhaps for years to come.
If nothing else, it is a reminder of the good that comes from a little perspective, and the fact that seeking to make assumptions based on a recent financial landscape that has been severely skewed by central bank stimulus and repression will likely lead us into a full-blown crisis. A set of wrong conclusions.
Both can be true of course – momentum could be ready for a correction after an exhilarating short-term move and be in the early stages of a longer-term purple patch. But what may look like a big bubble in the context of a few weeks and months seems much less terrifying when you realize that some trends take years and even decades to emerge.
