By Tim Courtney, Chief Investment Officer
Researchers have identified several key factors that influence stock and bond performance. For bonds, default risk and term length are factors that influence returns. For stocks, valuation, company size, and profitability (or quality) are common factors that help explain performance. Over the last two years, though, there has been one factor that has overwhelmed all others in stock returns: momentum.
Most factors are aligned with the principle that risk and return are related. In most time periods, bonds with a higher risk of default or longer terms tend to produce higher returns.1 For stocks, those with lower prices (scaled by profitability, book value, cash flows) or with smaller capitalizations are seen as riskier, and also tend to produce higher returns over most time periods.2
Momentum, however, doesn’t follow that principle. Like physical momentum, security momentum just reflects the tendency for securities that have recently outperformed (or underperformed) to continue moving in that same direction. Over the last few years this factor has been the dominant factor in US stock markets. The “Magnificent Seven” stocks have led the charge, supported by enthusiasm for AI’s potential future profits.3 Momentum is also the primary driver in returns of cryptocurrencies,4 benefitting from bullish investor sentiment. These assets, regardless of their price, size, or profitability have maintained their price movement.5
Momentum is unpredictable and often reverses as the stock begins to revert back to a mean.6 Capturing momentum in a single stock is difficult and often requires constant trading. Strategies that are mainly based on momentum can generate annual turnovers near 100% as stocks may qualify as momentum stock for only a quarter or two before mean reverting.7
In 2023 and 2024, the market wanted to own momentum stocks over any other— without concern for price or profitability. Much of that was based on AI, as investors were willing to continue to bid up AI-related names. But like physical momentum, security momentum doesn’t last forever. Other forces like competition, changing tastes and sentiment, regulation, and excessive expectations act like friction and slow momentum.
Because momentum eventually fades we should always be looking to be, as we say, an accommodating investor. That means being willing to pare or sell an asset that has achieved a price that appears rich as many momentum stocks do today. We should consider how portfolios are positioned for long-term success by considering all factors in performance. Reach out to your Exencial advisor to ask questions, explore strategies that make sense for your goals, and share your thoughts with us.
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PAST PERFORMANCE IS NOT AN INDICATION OF FUTURE RETURNS. Information and opinions provided herein reflect the views of the author as of the publication date of this article. Such views and opinions are subject to change at any point and without notice. Some of the information provided herein was obtained from third-party sources believed to be reliable but such information is not guaranteed to be accurate. In addition, the links provided within are for convenience only and the provision of the links does not imply any sponsorship, endorsement, or approval of any of the content. We do not guarantee the content or its accuracy and completeness. The content is being provided for informational purposes only, and nothing within is, or is intended to constitute, investment, tax, or legal advice or a recommendation to buy or sell any types of securities or investments. The author has not taken into account the investment objectives, financial situation, or particular needs of any individual investor. Any forward-looking statements or forecasts are based on assumptions only, and actual results are expected to vary from any such statements or forecasts. No reliance should be placed on any such statements or forecasts when making any investment decision. Any assumptions and projections displayed are estimates, hypothetical in nature, and meant to serve solely as a guideline. No investment decision should be made based solely on any information provided herein and the author is not responsible for the consequences of any decisions or actions taken as a result of information provided in this book. There is a risk of loss from an investment in securities, including the risk of total loss of principal, which an investor will need to be prepared to bear. Different types of investments involve varying degrees of risk, and there can be no assurance that any specific investment will be profitable or suitable for a particular investor’s financial situation or risk tolerance. Exencial Wealth Advisors, LLC (“EWA”) is an investment adviser registered with the Securities & Exchange Commission (SEC). However, such registration does not imply a certain level of skill or training and no inference to the contrary should be made. EWA may only transact business in those states in which it is registered, notice filed, or qualifies for an exemption or exclusion from registration or notice filing requirements. Complete information about our services and fees is contained in our Form ADV Part 2A (Disclosure Brochure), a copy of which can be obtained at www.adviserinfo.sec.gov or by calling us at 888-478-1971.
The Magnificent Seven refers to a group of high-performing companies which include Alphabet, Amazon, Apple, Meta Platforms, Microsoft, NVIDIA, and Tesla.