It has been for around a decade that value stocks have been getting hammered by growth stocks. The rut has been so bad that many have given up on the discipline altogether. But recently, something has been changing. Momentum stocks, long the darling of this bull market, have started to lag their value-oriented peers. This change started last week and is continuing today, and follows the worst month for value stocks in at least 20 years (this past August).
FINSUM: This is an encouraging sign, but certainly is not enough to say “value stocks are back!”.
Want to know one of the biggest risks in equity markets right now—parity, and we don’t mean between asset classes, we mean between investors’ portfolios. Momentum buying, or buying up stocks that have performed the best, has become such a hot strategy this year that both mutual fund holdings and hedge fund holdings look very similar. Everyone has the same basket of stocks, such as Mastercard, Paypal, Amazon, and Microsoft.
FINSUM: Since value investing has all but died—no one is interested in undervalued stocks—portfolio parity is increasing. This seems like a big risk that will magnify a reversal.
Small caps socks are having a rough year relative to the S&P 500. The Russell 2000 is up 15%, but behind the 19% gain of large caps. However, one area of small caps is doing great—momentum small caps, which are ahead of even their large cap cousins. Funds like the Invesco DWA SmallCap Momentum (DWAS), are up 26% this year through Wednesday. The fund aims to match the performance of the best 10% of stocks in the Russell 2000. Speaking broadly on the performance, the head of research at Nasdaq Dorset Wright says “Momentum can thrive in a market where you have a wide range of dispersions, and that’s especially true in the small-cap space, where you can have a big difference between the best and worst performers”.
FINSUM: There is a quite a variance in performance and financial conditions of small cap companies, and given the prevailing environment, that is creating highly differential results, which is great for momentum funds.
Any investor in ETFs will have noticed the marked rise of “factors” over the last few years. These are technical or conceptual overlays that managers use to create a theme for a fund. They are generally predicated on some type of data, like “quality” or “momentum”, both of which are well-studied. However, lately there has been an explosion of new factors which are being employed in funds. The problem is that many of these are not being observed on a long enough timeline to see if they are relevant. In practice, this means that a lot of funds are predicated around strategies that do not have any proof of concept.
FINSUM: So we have mixed feelings about this. On the one hand, some factors seem clearly frivolous, while others which may also be quite new, seem to be a good angle on the current market environment. The key is to be very discerning in choosing these types of funds.
There are a lot of worrying signs out there right now, but one thing that has bolstered optimism is the strength of the stock market in 2019. That said, there are signs appearing that underlying fundamentals are weakening. In particular, daily moves are shrinking, down from 0.9% in the 4 months leading to February, to just 0.4% in February. The slowdown in trading momentum is not only worrying in its own right, but also because the exact same trend appeared before the falls of February and December 2018.
FINSUM: Our counter argument is that average index moves were quite small through several solid years between 2014 and 2018, so it dos not necessarily indicate a problem.