An investing strategy that capitalizes on the widening gap between market winners and losers is proving to be highly effective this year, surpassing the performance of the S&P 500. Momentum investing—an approach that involves buying stocks with strong price or earnings momentum while shorting those with dwindling momentum—is gaining traction, according to a recent report from Société Générale.
Andrew Lapthorne, the global head of quantitative research at SocGen, highlighted that momentum trading is benefitting from what he describes as an “unusual divergence between winners and losers” in the market. He noted that current indicators suggest momentum factors are playing a significant role in driving market trends. This has resulted in impressive gains for momentum strategies across major markets in the U.S., Europe, and Japan.
In the U.S., momentum portfolios that focus on long price momentum—where investors buy the stocks performing the best—and short price momentum—where investors short the market’s biggest decliners—have shown notable returns since last October. The performance of the iShares MSCI USA Momentum Factor ETF, a well-regarded momentum-based fund, exemplifies this success, boasting an increase of over 20% year to date, outpacing the S&P 500’s 8% gain.
This momentum strategy has become increasingly attractive as the disparity between the top and worst performers in the market has widened, particularly influenced by the ongoing rally in artificial intelligence (AI) stocks. The situation has been further exacerbated by geopolitical tensions, including the conflict in Iran, which has driven oil prices up, contributing to significant gains in the energy sector.
So far this year, the contrast between the best-performing sector—energy—and the worst-performing sector—health care—has reached a staggering 35 percentage points. Additionally, the gap between long and short price momentum portfolios has been expanding since October, suggesting a persistent trend.
Lapthorne speculated that fears surrounding potential AI disruptions, rising inflation, and geopolitical strife could be contributors to this widening disparity. However, he noted that the primary driver of the trend remains uncertain. Importantly, he indicated that the negative correlation between long and short portfolios is rare, highlighting that such conditions have only been sustained during exceptional circumstances, such as the Covid pandemic.
The ongoing trends indicate that market participants are increasingly looking to capitalize on the momentum strategy, making it a focal point of investment discussions and strategies moving forward. The landscape continues to evolve, pointing to a fascinating year ahead for investors navigating these complexities.
