Last week, many investors found themselves caught unaware by a sell-off in momentum, which took its worst tumble in more than a decade.
As reported by CNBC, there was a dramatic rotation from high-valuation stocks that have driven the market to steady companies with lower valuations. Momentum shares — those that have gained consistently over the previous six to 12 months — slid by as much as 14% in the trailing period going back to August 27, which was reportedly the group’s worst move since the bull market began in March 2009.
Analysts and pundits came forward with multiple theories. Some cited a perceived improvement in U.S.-China trade negotiations and better-than expected economic data that eased the pessimism that had driven momentum this summer. Others say investors took their cues from a jump in government bond yields that, in some cases, were brought out of historic lows.
But even before it happened, the potential for such a whiplash-inducing event had been clear to Stephen Duench, Vice-President and Portfolio Manager with Highstreet Asset Management Inc., an AGF company, and a key contributor to AGF’s quantitative investment platform, AGFiQ.
“We’ve seen wild inflection points. We’ve seen a re-acceleration of momentum that we’ve never seen before,” Duench said in a video commentary posted on September 10.
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Prior to the rotation, he noted that the momentum trade had accelerated to an unprecedented degree. The last time that momentum had been stretched to a comparable extent was in 2016, when momentum was generally tied to growth stocks; that was followed by a sell-off where such stocks “rolled over quite substantially.”
“Right now it’s the low-volatility stocks that are momentum, which is very, very rare,” Duench said of the market at the time. He also noted how investors across the globe had shunned value, crowding into the same pockets of equities across the planet.
“The most extreme levels that we’ve seen are in the U.S. and Canada,” he said.
It wasn’t just low-volatility stocks that were hot; he noted that momentum characteristics had permeated into some growth stocks as well.
There generally comes a point when factors revert to the mean, Duench said, adding that momentum and other factors that were at that point crowded tended to revert more aggressively.
“So their hit rates are quite good, but their drawdowns are massive,” he said. “When you see momentum stretched to the extent that it’s stretched right now, it’s generally a time that you want to be a little bit more prudent with your positioning and not chase.”
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