Historical perspective on the shifting market leadership experienced over the past few weeks.
Momentum stocks have had a rough few weeks. We saw many of the high momentum stocks pull back sharply in the first half of July after a banner second quarter for the factor. One of the ways we track the strength of the momentum trade is through our RS Spread indicator (RSSPREAD). This reading looks at the top 1000 stocks by market capitalization, separates them into quintiles based on trailing momentum (performance-based), and then subtracts the bottom quintile from the top quintile. In short, it tells us how well market leadership is faring against the laggards. Seeing the RSSPREAD push higher is indicative of a positive momentum environment; the gap between leaders and laggards is widening.
That is exactly what we saw in the second quarter. The RSSPREAD reached 24.50 on June 22, climbing from 19.79 on March 24. While that might not seem like much, that 24% improvement in a 90-day stretch is the third largest rise we have seen over any 90-day period since 2008. The other two times include the period ending in March 2020 and November 2022. Obviously, everyone remembers March 2020 as the bottom of the pandemic-induced bear market, but you might have forgotten that high momentum names held up better than the low momentum names until the market washout at the end of that month. In November 2022, we were coming out of another bear market environment as AI moved to the centerstage following the general release of ChatGPT.
The highest periods of improvement we have ever seen for the RSSPREAD came during the intensely volatile environments from 1998 – 2002 and 2008 – 2009. While they saw some sharp runs for momentum, those runs were often short-lived and followed by intense deterioration. Those market environments caused substantial whipsaws in the momentum trade due to the lack of clear trends throughout the market.
There are significant differences between the current market environment and any of these prior periods. We are not coming out of a bear market like we were in 2020 or 2022. We do not see wildly stretched valuations like we saw heading into the dot-com crash, nor do we see the economic concerns that we saw heading into the global financial crisis. Every market environment is different. The only consistent theme we can see across each of the major periods of improvement for momentum is that they were followed by sharp mean reversion. That is due to how momentum functions; leaders must undergo a period of underperformance to show they are no longer leaders.
This momentum unwind is what we have experienced over the past few weeks. Technology was the big winner in the second quarter, led higher by semiconductors. That sector rocketed higher in our DALI sector rankings, gaining over 50 signals in May to move from the third to the first position. That was the sharpest ascent to the top position we have ever seen. Sectors will often show sharp improvement but fall short of gaining enough relative strength to knock off the top ranked areas. That was not the case for technology, as it not only moved into the top position but continued to climb, ultimately reaching a 55 signal gap between itself and industrials in second.
That trade turned around quickly as we entered July. Technology dropped 56 RS buy signals from the 30 day stretch through July 16, leading it to drop down into the second position in our DALI rankings. This is a very large signal decline in a short amount of time, but other 30 day stretches have shown more substantial losses for tech, such as April 2025 (83 signals) and March 2004 (67 signals). The extreme technology improvement could not go on forever, as we have now seen the sector come back down to earth. Technology still sits in the second position for now, in an overweight posture but no longer the clear leader for domestic equities.
On the other hand, we are seeing that strength transition to other areas of the market. Healthcare has been the biggest beneficiary in relative strength, adding 46 RS buy signals over the past 30 days. Financials is the next highest at a 27-signal improvement, followed by consumer discretionary gaining 25 signals. This is a diverse mix of names to rise in relative strength as we head into earnings season. Some of the improvements in healthcare and financials seems to be related to process improvements or cost savings due to AI implementation, which could end up looping back around to help technology. Consumer discretionary had done surprisingly poorly for such a risk-on market environment, so seeing that sector improve can be viewed as a good thing for the broader economy.
We do not know the extent of this rotation, but we know that the momentum factor will continue to push the portfolio toward the strongest areas of the market. It is important to stick with the process and follow what works over time during periods of uncertainty. This is what all our RS based models and strategies look to do, overweight strength and avoid weakness.
