High-momentum stocks have been losing steam and this could be signaling a market top
High-momentum stocks, which are risky at any time of the market cycle, are particularly so in the weeks prior to a bull market top. That’s the conclusion I reached upon analyzing all U.S. bull markets since 1926. Stocks that are riding a wave of momentum do not crest in unison with the broad market averages. They instead start to lose steam several weeks in advance.
This is why momentum stocks’ recent behavior is potentially worrisome. Consider the iShares MSCI USA Momentum Factor ETF MTUM,
This does not guarantee that a market top is imminent, needless to say. It’s worth noting that this ETF has been strong so far this April, even with Monday’s sharp decline. But the ETF’s dismal first-quarter performance nevertheless is ominous.
Consider what I found upon analyzing high- and low-momentum stocks since 1926, based on data compiled by Dartmouth College professor Ken French. The high-momentum portfolio contained the 10% of stocks with the best trailing-year returns, while the low-momentum portfolio contained the decile with the worst trailing returns. I calculated these two portfolios’ returns in the final weeks of all bull markets in the bull-market calendar maintained by Ned Davis Research.
Contrary to the usual pattern in which the high-momentum portfolio comes out ahead, the low-momentum portfolio comes out on top in those final weeks, on average.
Why might that be? My hunch is that market leadership typically changes as bull markets near their end. The stocks that begin to show the greatest relative strength will be those in recession-resistant industries, such as Consumer Staples, as investors look around the curve to anticipate what’s coming down the pike. In contrast, stocks in the most economically sensitive industries (such as Energy) will begin to exhibit relative weakness. This change in leadership can sabotage momentum strategies, which are an implicit bet that what has been strongest in the immediate past will continue to be.
This failure of momentum near market tops in turn illustrates a broader point: Market tops are gradual, rolling affairs rather than one-day about-faces. So it behooves us to pay attention to the market’s internals rather than to the broad market averages alone. The performance of momentum stock strategies is one such internal.
Another straw in the wind: The top-performing newsletters I monitor currently are betting that low-momentum stocks will outperform high-momentum issues. I reached this conclusion after constructing two 50-stock lists. The first contained those within the S&P 1500 with the best performance over the last 12 months, and the second contained those with the worst. Currently, none of the top performing stocks is recommended by even two of the top performing newsletters.
In contrast, three of the worst performing stocks are recommended by more than one of these top-performing newsletters:
Mark Hulbert is a regular contributor to MarketWatch. His Hulbert Ratings tracks investment newsletters that pay a flat fee to be audited. He can be reached at [email protected]
Also read: The Dow and the Nasdaq are diverging. Why that’s honey for stock market bears
