(Bloomberg) -- For the math wizards of Wall Street, it was a once-in-a-decade stock rotation that at one point conjured memories of the pre-crisis “quant quake.” Now systematic investors are butting heads over what comes next.
The sudden plunge of this year’s winning stocks and resurgence of the losers is the start of a trend, according to the likes of Bank of America Corp., JPMorgan Chase & Co., Jefferies Inc. and PanAgora Asset Management Inc. They argue the conditions that preceded it -- a relentless surge of so-called momentum shares versus their peers -- went too far as investors charged into defensive names.
Yet for naysayers including Evercore ISI and Goldman Sachs Group Inc., the recent reversal was little more than short-covering in a business cycle in the winter of its expansion.
A sudden revival of animal spirits is behind all the soul-searching. That sent momentum shares to their worst week since 2009, and the factor to its best in the same period, according to Bloomberg indexes. In a sign of the violent stock moves lashing quants, as of late Tuesday morning in New York momentum was headed for its best day since 2011, while was down.
At issue is the fate of billions of dollars tracking factors -- investing styles that dissect equities according to characteristics like and momentum -- as investors size up recession risk.
A bullish case is emerging for those betting on a lasting shift: Global economic data haven’t delivered such positive surprises in more than a year, and central bank stimulus can extend the market cycle. That should be good news for , or cheap stocks which are deemed higher risk. An oil spike boosting battered energy shares -- part of the cohort given their volatile nature -- only strengthens the case.
“It’s overdue,” said George Mussalli, chief investment officer at PanAgora Asset. “If you look at stocks like AT&T and GM, they haven’t gone anywhere in three years while the whole market has rallied.”
Yet timing factor performance can be a thankless task, as many bulls will testify. Before this month, investors had been piling into the defensive shares such as utilities and soap makers that make up momentum portfolios and shunning riskier stocks along the way.
As big as September’s rotation was, there have been similar shifts in the past year -- quickly snuffed out as investors returned to safer bets amid lingering fears over growth and the trade war. The question is whether last week’s spirited rotation has legs.
Bank of America points to improving economic data and forecasts for re-accelerating profit growth from the end of this year -- paving the way for conditions that benefit the car makers and banks that typically populate baskets.
Even after its recent rally, is still incredibly cheap versus growth stocks. The former’s strongly negative correlation with momentum suggests positioning is still stretched, strategists led by strategists led by Savita Subramanian argue, meaning outperformance for cheap shares is likely to follow.
“Crowding risk in momentum relative to remained elevated, causing additional pressure for the spring to uncoil,” they wrote in a Monday note.
To skeptics, last week’s move was a blip. Investors flocked earlier to defensive stocks which then became momentum, and they avoided because they were anxious over the economic outlook. The business cycle looked extended and U.S.-China trade tensions were riding high -- conditions that have barely changed.
“Short term, the rotation favoring should continue” to be supported by rising yields, Evercore ISI strategists led by Dennis DeBusschere wrote in a note. “However, as the outlook for global growth remains weak, the recent reversal into is more a short-term rebound than a long-term trend.”
Strategists at Goldman Sachs are similarly unconvinced, pointing to still low bond yields and weak growth prospects.
Recent history may be on their side. The last time momentum plunged by as much in one day in 2009, it surged by nearly as much less than two weeks later, Bloomberg portfolios show. A similar reversal occurred after ’s jump in 2008.
For adherents like PanAgora’s Mussalli, however, there are lessons further back in time. After the dot-com bubble burst, previously unloved cheap stocks saw a period of stellar outperformance.
The bond yield curve is also starting to steepen, a trend that tends to favor and signal a rosier economic picture. That’s another sign the shift into cyclical and more volatile shares will continue, according to Jefferies.
“Risk aversion has been rife and position unwinding suggests a lot of room for high beta and cyclicals to perform,” strategists led by Sean Darby wrote in a note.
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