Recovery in Momentum Stocks May Be Just as Ominous as the Collapse

(Bloomberg) -- The September sell-off in U.S. momentum stocks is well on the way to being repaired, but the speed of the rebound is a warning sign of more volatility ahead, according to Sundial Capital Research Inc.

Their recent recovery is one of the largest, quickest reversals in history, said Sundial founder Jason Goepfert in a note to clients Thursday. While similar moves in the past have preceded large long-term gains, shorter-term returns suffered from an increase in volatility, with some big losses, he said.

Recovery in Momentum Stocks May Be Just as Ominous as the Collapse

Looking at outsized momentum swings going back as far as the 1930s, Sundial found that both the average maximum gain and maximum loss in the S&P 500 Index over the following three months were in excess of 9%. Those moves are “huge” relative to the norm, according to the note.

“Every time these types of stocks cycled from a big loss to big gain within a couple of months, it wasn’t necessarily a good sign,” Goepfert said. “It’s not the drop that’s concerning, it’s the simple fact of their volatility.”

Momentum funds, which buy stocks on winning streaks and sell losers, have outperformed in the U.S. in recent years, with technology, defensive and so-called bond-proxy names all enjoying periods of dominance. The strategy came undone last month -- the Dow Jones U.S. Thematic Market Neutral Momentum Index lost 12% through Sept. 13 -- as a rise in bond yields spurred a switch to value shares.

The gauge has rallied 10% since.

“Some will take the recovery in momentum stocks as a sign that the worst is over,” Goepfert said. “Maybe it is, but the worrying part is that they’ve gyrated so wildly in the first place, in both directions.”

©2019 Bloomberg L.P.

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