Harrowing Plunge in Momentum Stocks May End Up a Market Blessing

(Bloomberg) -- As painful as it is to watch your favorites get punched, one school of thought suggests this week’s momentum meltdown may turn out to be good news for the market.

Take a look at how this episode differs from the February rout. Back then, stocks that had beaten the market in recent months kept rising relative to the S&P 500 Index during the first leg down. An initial attempt in the S&P 500 to bounce failed, and stocks didn’t stop falling until momentum yielded. Effectively, the index traced out a W-shaped pattern where stocks took roughly seven months to fully recover.

This time, momentum stocks bore the brunt of the selling right away. During Wednesday’s carnage, winning groups such as tech led the retreat and the FANG block of Facebook Inc., Google parent Alphabet Inc., Amazon.com Inc. and Netflix Inc. sank the most on record.

Harrowing Plunge in Momentum Stocks May End Up a Market Blessing

The violence of this selloff suggests a fast deterioration in investor sentiment, sometimes a sign of capitulation that indicates a bottom isn’t far away. It’s in stark contrast to February, when retail investors and fundamental-conscious money managers held out in the face of computer-driven selling before finally giving in, according to Ben Onatibia, a strategist at Vanda Research.

“The fact that momentum stocks underperformed points to a fundamental-driven selloff,” Onatibia wrote in a note to clients. “This means that a V-shaped recovery is more likely than the W that characterized previous quant sell-offs.”

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