BlackRock may be Wall Street’s last high-profile supporter of a quant strategy that’s flipped from the bull market’s biggest driver to its most-conspicuous laggard.
The world’s largest money manager is touting momentum stocks even as its own ETF tracking the style suffers its longest outflow streak ever and the market-neutral version of the trade clocks the worst year-to-date performance of any factor.
As investors dumped growth and cyclical stocks during last year’s equity meltdown, the trend-following style became more correlated with defensive names, spurring its underperformance this year as risk-on trades boom.
Yet for BlackRock, valuations, relative strength and dispersion all counsel for staying the course on what has been a reliable market-beater for years — but which has become deeply unpopular during this stock rally.
Winners turning into losers and back again is a textbook late-cycle dynamic — one reason traders are beating a retreat from a strategy that typically buys the biggest gainers over the previous 12 months.
“We find that relative strength on momentum continues to be strong, and since that’s one of our inputs, we’re bullish on it,” said Holly Framsted, head of U.S. factor ETFs within BlackRock’s ETF and index investments group.
It’s a contrarian position, to say the least.
Traders are fleeing the factor as the fourth quarter’s abrupt $5 trillion U.S. stock sell-off left the trend-following strategy largely rudderless. Momentum has become highly correlated with equities like utilities and less in sync with those that tend to power rallies like tech, according to Macro Risk Advisors.
Strategists have turned on it, too. Bank of America Merrill Lynch recommends investors buy quality stocks instead while Sanford C. Bernstein dislikes the stretched valuations of shares that comprise the factor, which typically performs best during sustained market trends and low volatility.
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A tranquil, one-way bull market kept momentum stocks near the top of the leader board for years as winning shares kept winning. BlackRock’s iShares Edge MSCI USA Momentum Factor ETF (MTUM) is up 115% since its 2013 inception, compared with 80% for the MSCI U.S.A. Index.
The BlackRock ETF has lagged the S&P 500 this year, driven by an ad hoc rebalancing that tilted the fund in favor of defensive stocks, while the market-neutral version of the broader strategy has slumped by nearly 3%.
“Momentum is not a great factor for turning points when there’s factor volatility because it’s in the process of reconstituting itself,” said Sean Phayre, global head of quantitative investments at Aberdeen Standard Investments.
For those who believe the global economy is staring down the barrel of the late-cycle gun, a slew of economic data pointing to slowing growth would also seem to counsel against betting big on momentum.
“If you are into factor timing, momentum would not be in my favored category for the current environment,” said Nick Kalivas, senior equity product strategist at Invesco ETFs. “I am betting that the economy is entering late cycle and volatility will be elevated. Neither has been historically kind to momentum.”
The Fed’s pause on interest rate hikes has been a “net positive” for the category, an expert says.
To be fair, BlackRock has reduced its exposure from a maximum overweight in October to a moderate overweight, and while Framsted is aware that its position is “a bit counter to the current market sentiment,” she says the factor can still deliver late in the economic cycle.
“While it’s true momentum has tended to perform best in expansions, it can also be resilient in economic slowdowns where stable growth maintains trends,” she said.
Over at Legal & General, Andrzej Pioch is mulling a bullish scenario that could give the factor a lift.
The money manager on L&G’s multi-factor team says that as December’s sell-off recedes further into the past, momentum could have room to run — but only if the Fed remains dovish, inflation subdued and trade developments turn more encouraging.
“With the significant inflection point behind us, we might be at a relatively more favorable environment for the momentum factor,” he said.
