Traders work on the floor at the New York Stock Exchange. — Reuters
New York: For all the Trump Trade triumphalism and hysteria for artificial intelligence (AI), it’s been a tough year to make money across markets.
Now even the trade that powered US stocks is starting to show signs of wavering.
A fickle US Federal Reserve and inflation’s refusal to go quietly has been a recipe for cross-asset malaise.
The biggest exchange-traded fund (ETF) tracking long-dated US Treasuries swung violently in 2024 before finishing deeply in the red.
Commodities rode the hopes and dreams of Chinese stimulus, up and down.
Gains were even squeezed in the safest credits, where spiking yields pushed BlackRock’s US$30bil investment-grade ETF to its worst fourth quarter in eight years.
The one bright spot was equities, and US companies again stole the show.
The advance was the furthest thing from a uniform march, though – including last Friday, when a normally sleepy year-end session saw the S&P 500 fall as much as 1.7% on no obvious news.
That drop capped a year when value and small-cap shares struggled, and the S&P 500’s 25% return masked a gain of half that in its average member.
Ominously, it was also the second shellacking in as many weeks for the one equity strategy that has worked reliably in 2024: momentum investing, or riding the market’s winners. A record year for momentum has rewarded its faithful handsomely – while also raising risk that blow-ups like last Friday’s will become more common.
“Momentum is great until it’s not, until something changes,” said Melissa Brown, head of applied research at SimCorp, which offers factor risk models.
Even with last week’s pullback, the popular quant trade that buys the past year’s top names and sells the losers has gained 31% in 2024, set for the best year ever in data going back to 2002, a S&P Dow Jones index shows.
In short, the stock leaderboard proved remarkably consistent, with Big Tech favourites like Nvidia Corp and Meta Platforms Inc sitting steadily at the top. While that’s handed an easy gain to anyone with an index fund, the all-too-familiar setup is adding fuel to concerns that stock gains have become too concentrated and crowded.
That’s against a backdrop of too many twists to count, starting with a US central bank that was at times dovish, then hawkish again, and encompassing everything from worldwide election drama and simmering geopolitical tension to China’s varying postures toward economic stimulus.
So numerous were the cross-currents that a strategy built for all-weather success, the multi-asset portfolio model known as risk parity, ended the year roughly unchanged, as measured by the RPAR Risk Parity ETF.
The momentum strategy, an approach widely used by quantitative traders and backed by academic research, captures the tendency for market trends to persist for a while, whether it’s because more investors are jumping in or are late to absorb new information. It reallocates into recent winners in every rebalance, helping it capture medium to long-term trends.
That has happened this year. In addition to betting big on tech, momentum managed to break out of its summer doldrums by adding more cyclical names that ended up profiting from Donald Trump’s victory, says Bruno Taillardat, head of smart beta at Amundi.
The strategy’s whopping gains have intensified worries that momentum has now become self-fulfilling in stocks, especially with the growing dominance of passive funds.
“Another consideration is the growing propensity of investors to use price momentum as a key factor in their investment strategy,” Michael Wilson, chief US equity strategist at Morgan Stanley, wrote in a note yesterday. “Many investors have let their winners run, given the lack of mean reversion in the past several years.”
He pointed to one anomaly: The S&P 500 has managed to keep rallying, despite the small number of its members that are rising above their 200-day moving average.
In credit, buying bonds issued by companies with higher stock momentum has also been a winning strategy in 2024, said Patrick Houweling, head of quant fixed income at Robeco. But in a risk-on year, the value factor – or buying bonds with unusually wide spreads – has fared the best.
That’s unlike the stock market, where the cheapest shares have underperformed and extended momentum gains have only made the winners more expensive relative to the losers. Such wide valuation spreads might be fuelling higher volatility in the strategy, 22V strategists led by Dennis DeBusschere wrote in a note.
S&P’s momentum index dropped 0.7% last week as the S&P 500 pared gains to just 0.7%.
“Outside of periods of acute shock, the price-earnings spreads in momentum rarely get above current levels,” the team said, referring to the difference between the price-earnings ratios of high-momentum stocks and those of lower-momentum shares.
“Room for another sharp increase in momentum looks increasingly limited.” — Bloomberg
