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Roula Khalaf, Editor of the FT, selects her favourite stories in this weekly newsletter.
Edward Cole is head of multi-strategy equities at Man Group.
In physics, the more momentum an object has, the harder it is to stop. We’ve now witnessed several periods in which the momentum factor seemed to be running out of steam, only for it to come surging back.
But ‘Momo’ now is on a tear to such an extent that it feels like it might be time to declare mean reversion a thing of the past and be done with it.
As a reminder, momentum is an investment factor or strategy that seeks to exploit the fact the stocks that have performed well in the past tend to perform well in the future, at least up to a point. One of the things about momentum is that it does very well . . . until it doesn’t.
Reversals — when they come — can hit hard. In 2009, there was a 73 per cent drawdown in the factor. In 1932, it dropped more than 90 per cent. Smaller but still painful momentum reversals hit in the wake of the dotcom boom and again in November 2022.
As FT Alphaville has reported, hedge fund strategies are — in their long books at least — currently more concentrated in the momentum factor than at any other time in history.
Intuitively, this makes sense. Indeed, you could see the spike in momentum as a corollary of the concentration we can currently see in US stocks — a wave of money chasing the same handful of tech winners, the fact that long beta has done remarkably well over the past 18 months or so. It’s notable that the recent wobbles in the factor were driven by a momentary breather in the inexorable rise of Nvidia.
So, are we currently experiencing a bubble in momentum? And should we be anticipating a reversal?
The first thing to say is that, until the latest AI-induced spike, momentum was actually having a pretty underwhelming time as a factor. Momentum relies on the persistence of leadership — winners keep winning — and the second half of the 2010s and the first few years of the 2020s saw a number of challenges to leadership, with a mixture of geopolitics, Covid-19 and inflation concerns driving a lacklustre few years for the factor.
So, far from entering bubble territory, momentum could have a fair way to run. If you want to see what Momentum looks like during a real bubble, take a look at the period in the run-up to the dotcom crash, or the global financial crisis. It’s clear to us that, while we have seen a significant run-up in the factor when compared to recent levels, we are far from the one-way traffic seen during those periods of irrational exuberance.
If we look back further into the history of the factor, we can see that the kind of volatility that momentum saw in the late-2010s is more the exception than the rule. Momentum enjoyed prolonged multi-year periods of outperformance in the 1960s and again in the 1980s.
It’s worth thinking about what links these periods: they saw strong nominal GDP growth driven by higher consumer spending and a housing boom; they saw moderate but not persistently low inflation; they saw increasing participation in stock markets; they saw technological innovations that dramatically altered the fabric of everyday life.
It’s not all that hard to think — OK, perhaps with some level of Panglossian rose-tinting — that the years to come might hold something similar. If you believe that the economic picture over the coming years is positive — a soft/no landing scenario — then you might expect a continuation of momentum’s upward trend, possibly for years to come.
If nothing else, it’s a reminder of the benefit that comes from a bit of perspective, and the fact that seeking to build assumptions based on a recent financial landscape that has been deeply skewed by central bank stimulus and repression will probably lead us to a whole host of wrong conclusions.
Both things can, of course, be true – momentum can be ripe for a correction after a euphoric short-term move and be in the early stages of a prolonged purple patch. But what might seem like a big stonking bubble in the context of a few weeks and months looks a lot less scary when you recognise that some trends take years and even decades to play out.
