Alarm Bells Sounding Over Gigantic Run-Up in Momentum Stocks

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(Bloomberg) -- One of the most lucrative strategies in stock investing this year may be heading for a pause.

Investors betting on momentum, or the continuation of existing market trends, have made a killing thus far in 2017, with indexes tracking the strategy in the U.S. and Europe at or near record highs. Now, firms including Morgan Stanley and JPMorgan Chase & Co. are predicting that the trade -- akin to piling into technology stocks, this year’s top stock-market performers -- could be getting stretched.

Their calls come at a time when rotation between stock winners and laggards in the regions is becoming more frequent. In the latest example on Wednesday, media, transportation and household-products companies in the U.S. -- among the worst-performing sectors in the S&P 500 Index this year -- rallied amid a tech rout. The trend played out similarly in Europe, where the tech sector was among the biggest industry losers in November, while the underperforming real estate sector gained the most.

“Investors should be aware of a growing risk of a reversal in this factor in the months ahead,” Morgan Stanley strategists wrote in a recent note. “This momentum set-up will likely magnify the effects of sector rotation when it does occur.”

JPMorgan says the rotation away from momentum stocks could continue if President Donald Trump and the Republican Congress succeed in their tax overhaul efforts. Equity investors who think the administration’s pro-growth fiscal policies will save financial institutions from paying billions in taxes are piling into banks instead, as U.S.-listed tech behemoths have relatively low effective tax rates and don’t stand to benefit as much.

The lender recommends fund managers who are overweight momentum and growth stocks take a defensive approach to tax reform by buying near-term protection.

The Stoxx 600 tech gauge was the second-worst performer among European industry groups as of 2 p.m. in London Friday.

READ: JPMorgan Sees Pain for Growth Stocks and Their Hedge Fund Fans

Momentum stocks’ growth this year is staggering. The MSCI USA Momentum Index is heading for its biggest yearly gain since 1999, while its European peer has climbed almost four times as much as last year in percentage terms.

That performance is causing some traders to lock in their profits. MPPM EK’s head of trading Guillermo Hernandez Sampere says his Eppstein, Germany-based firm has been reducing exposure to technology and buying telecom and financial stocks for the past two months.

“What happened this week is a warning about what could happen to momentum stocks -- it’s very crowded there, so you feel it immediately when some people are leaving the crowd,” Hernandez Sampere said by phone. “At this time of year, if a momentum stock had a good run it may be a smart thing to shift into the laggard.”

©2017 Bloomberg L.P.

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