Momentum Trade Plunges the Most on Record in Rotation Frenzy

(Bloomberg) -- One of the hottest quant strategies of this bull market is taking a beating in Monday trading, in one of the most dramatic equity rotations of the coronavirus era.

After Pfizer Inc. revealed its Covid-19 vaccine prevented more than 90% of infections in a large-scale study, the momentum factor -- which buys the past year’s winners and dumps its losers -- plunged 3.4% in early New York trading. That’s the biggest intraday drop since records began in 2000.

Investors are going all-in on risk-on trades and paring back defensive bets that have boomed through the crisis.

The momentum style has largely morphed into a bet against cyclical shares and in favor of companies that deliver profit growth untethered to the business cycle, such as Big Tech.

News of vaccine progress is adding fuel to a rotation that many strategists say was long in the making given how stretched the momentum trade has become.

“The ‘everything duration’ Goldilocks momentum trade -- long secular growth versus short cyclical value -- is likely going to see tectonic movement and at the very least, tactical unwind to play for this ‘economic reopening’ forward view,” Charlie McElligott, a strategist at Nomura Holdings Inc., wrote in a note.

Even before the Pfizer news, Sanford C. Bernstein strategists warned over the momentum factor’s soaring valuations, which are now more than two standard deviations above its historic average in the U.S. and Europe. In America, a measure of crowding in the factor has surged anew to multi-year highs.

Whether to chase some of the market’s most reliable winners like growth equities is a familiar dilemma. For much of the post-crisis period, Wall Street pros have kept sounding the alarm on pricey momentum and growth stocks -- only to watch them move higher.

That trend appeared to continue last week as Democrats’ likely failure to win the Senate last week prompted investors to lower expectations for a massive stimulus package and return to their old equity favorites.

Now, it looks like a successful vaccine could be the latest catalyst for a rotation. Yet, there is still a long way to go before any one of the candidates receives regulatory approval and is distributed widely enough for restaurants, offices, planes and shops to see a recovery in demand. Evercore ISI estimates normal life won’t return until the third quarter of next year.

On the plus side, a jump in Treasury yields on Monday is a sign the vaccine news has lifted optimism on economic growth. That should help risk-on bets like value, and dent the euphoria for tech stocks that are currently stuffed in momentum portfolios.

By definition, momentum tends to fare poorly in regime shifts.

“Reduced political uncertainty alongside strong results from Covid vaccine trials and improving fundamentals paves a way toward higher equity prices and a cyclical/value rally,” Evercore strategists led by Dennis Debusschere wrote in a note.

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