As global growth slows and the Federal Reserve looks to hike interest rates, exchange traded funds that track the momentum strategy could underperform. Alternatively, ETF investors should consider the quality style.
“Investors should be aware, however, that the good times may not last for long,” writes Russ Koesterich, managing director and BlackRock‘s global chief investment strategist. “Higher volatility should be expected given the recent evidence of slowing global growth and less benign credit conditions. This suggests to us that so-called momentum stocks, which have rallied strongly this year, could falter.”
So far this year, the momentum strategy has been paying off. The iShares MSCI USA Momentum Factor ETF (NYSEArca: MTUM) rose 9.5% and First Trust Dorsey Wright Focus 5 ETF (NasdaqGM: FV) increased 14.1%. The two ETFs track stocks and sectors that exhibit relatively higher momentum to other areas of the market.
Momentum describes securities that are more likely to keep moving in the same direction and experience a rate of acceleration in price or volume. Consequently, this strategy more often relies on short-term moves instead of fundamental factors.
However, potentially dampening the equities outlook, analysts have downwardly revised 2015 growth for G8 counties to 1.7% from 2% last fall. U.S. growth over the past several years was weaker than previously though, with productivity lower than anticipated. [Why to Expect More Volatility Ahead]
Meanwhile, rates on benchmark 10-year Treasuries have dipped below 2.2%, near their summer lows. Moreover, credit spreads, or difference between yields on U.S. Treasuries and credit instruments of comparable maturity, are widening.
“Both of these variables—growth expectations and credit market conditions—are important determinants of equity market volatility,” Koesterich added. “Last week, the VIX Index, a measure of stock market volatility, traded back down to 12, roughly 40% below its long-term average. This implies equity investors may be too complacent.”