Perhaps Surprisingly, Momentum Stocks Continue Standing Out

Increased market volatility is traditionally seen as a drag on momentum stocks, but the case for owning these stocks remains surprising and it could boost ETFs, such as the Principal Sustainable Momentum Index ETF (NasdaqGM: PMOM).

Central banks’ policy response to the coronavirus crisis is seen as a contributing force behind momentum sturdiness.

“While momentum typically struggles with volatility, it benefits from the policy reaction to volatility: more liquidity,” said BlackRock in a recent note. “As central banks have put their balance sheets at the disposal of fiscal spending, we have witnessed a surge in central bank asset holdings that has dwarfed the post-GFC response.”

Marveling at Momentum

Momentum investing can target those companies that are exhibiting high levels of growth. The momentum factor selects company stocks that have recently outperformed based on the idea that “the trend is your friend” and that stock market leaders typically continue to outperform. This type of strategy can be an effective way of targeting growth-oriented companies since stocks with positive momentum often continue to generate strong earnings.

Critical to the broader momentum thesis this year and that of PMOM is that value stocks continue disappointing investors. In theory, value is a less volatile factor, one ideally suited for these turbulent times.

“Value typically works at a market bottom because investors anticipate a strong recovery on the back of pent up demand,” notes BlackRock. “Today, circumstances are very different.  The recession was not caused by an aggressive Federal Reserve but by a devastating and unpredictable pathogen. Even as the pandemic subsides, unemployment may remain high and consumption muted due to lingering restrictions and changes to consumer sentiment and behavior, i.e. how long before people are comfortable heading back to restaurants, hotels or getting on an airplane?”

PMOM reflects the performance of the Nasdaq U.S. Sustainable Momentum Index, which uses a quantitative model to identify equity securities within the Nasdaq US Large Mid Cap Index that exhibit sustainable price momentum, based on historical stock prices over multiple periods and taking multiple market environments into consideration.

Adding to the near-term case for PMOM is that the momentum factor isn’t as cyclical as previously believed.

“For investors who came of age in the 1990s, we typically associate momentum with aggressive, high-beta names. Today, momentum has a somewhat different flavor,” according to BlackRock. “Most momentum baskets or funds are overweight secular themes, notably technology and increasingly healthcare, specifically biotech. To the extent these segments are more insulated than other parts of the economy, and in some cases stand to benefit from longer-term structural changes, this may further favor the style.”

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The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.