Momentum started this year off hot… until it wasn’t. While investors can’t turn back time and undo the damage that has already been done, we can offer context and potential optimism for momentum going forward.
Momentum started this year off hot, carried higher by technology and semiconductors… until it wasn’t. The iShares MSCI USA Momentum Factor ETF (MTUM) was up as much as 38% this year through June but has since fallen more than 27% from those highs. While investors can’t turn back time and undo the damage that has already been done, we can offer context and potential optimism for momentum going forward.
Uncharted Momentum Pullback
MTUM fell more than eight percent on 11/5 and is down 22.5% just over the last month, leading to a plethora of technical developments for the fund. It’s now on a streak of three consecutive sell signals, the most recent of which also moved the fund’s trend back to negative. MTUM holds a fund score of just 1.63, marking its lowest levels of strength since 2023. Suffice to say, things look unfortunate for the fund.
And if you thought things couldn’t get any rarer, then you’d be wrong. MTUM’s recent level of underperformance relative to the average stock hadn’t ever occurred prior to recent action. Specifically, MTUM has lagged the S&P 500 Equal Weight by around 25% over the last month. For context, the next worst period outside of this year was 17% from 2020. Said plainly, momentum investors are experiencing the worst month for the factor in at least the last thirty-four years. This relative movement caused MTUM to move to a market RS sell signal for the first time in around three years as well.
The Silver Lining
The good news is that momentum is typically self-correcting, as periods of underperformance gives way to either a rebound in existing leadership or a rotation towards new areas of strength. And currently, the oversold levels of momentum names do offer some optimism for the factor. MTUM’s overbought/oversold (OBOS) reading of -167% places it not only in oversold territory but also at a level of washout the fund has rarely ever experienced. Only July 1994, November 1996, and January 1999 have ever seen the fund at more oversold levels, highlighting the extreme nature of recent action.
Another way to view the effectiveness of momentum is by looking at how much the leaders (best performers) of the market have outpaced the laggards (worst performers). NDW looks at the Relative Strength Spread (RSSPREAD) as a proxy for exactly that—how much the leaders are outpacing the laggards. It takes the performance of the top quintile (best 20%) of stocks minus the bottom quintile (worst 20%) of stocks, showing the excess return of the leaders versus the laggards.
Over the last month, the market laggards have outperformed the leaders by more than 15% for just the 13th time since 1990. This also marks the second time in a span of a few months the RS Spread has pulled back so hard. However, similar momentum pullbacks have been positive for the factor more often than not. Overall, the leaders beat the laggards over the next year in two thirds of similar momentum declines, while leaders outperformed by an average of 14% over that span.
Not every instance has played out this cleanly, but the broader tendency has been for old leaders to rebound or new leaders to emerge, allowing the factor to flourish once again. Additionally, the worst periods for momentum typically come when the market rallies off a bottom, such as late 2002 and second half of the GFC. With the S&P 500 less than 6% from all-time highs, it’s hard to argue that we’re rallying off a major bottom soon. Regardless of where markets head, similar momentum reversals suggest the potential for momentum to reassert itself as trends stabilize.
