Monday, May 15, 2017

Momentum Strategy Leading Again

It is back to the future for the market as momentum is once again a leading investment strategy just as it was in 2015. Momentum fell out of favor in the run up to the election and into year-end 2016; however, momentum is once again leading the S&P 500 Index this year. The momentum strategy may be overbought near term with the RSI near 80.

One aspect of the momentum strategy is the MSCI USA Momentum Index (PDF) contains an outsized weighting in the technology sector. The momentum index construction is based on the following:
"A momentum value is determined for each stock in the MSCI parent index by combining the stock’s recent 12-month and 6-month local price performance. This momentum value is then risk-adjusted to determine the stock’s momentum score. A fixed number of securities with the highest momentum scores are included in each MSCI Momentum Index, generally covering about 30% of the parent index market cap. Constituents are weighted by the product of their momentum score and their market cap."
In the current market environment, this focus on momentum has lead to technology stocks  and technology stocks are outperforming the broader market.

In 2015 investors may recall it was the year of the FANGs as well. Facebook (FB), Amazon (AMZN), Netflix (NFLX), and Google/Alphabet (GOOGL) with the average return of these four FANG stocks equaling 83% while the S&P 500 Index was up only 1.4%. Looking at the 3-year annualized return for various indices through last Friday, the below chart shows the Nasdaq Composite Index and the MSCI Momentum Factor Index are both outpacing the S&P 500 Index.

The strength of technology, and similarity to 2015, is evident in the below table detailing return contribution of the FAANG holdings. Included in the basket is Apple (AAPL); hence, the double 'A' in FAANG. These five FAANG stocks have contributed 34% of the return for the S&P 500 Index on a year to date basis. In other words, 1% of the index holdings account for 34% of the returns this year. Certainly a narrow market.

The focus on these larger technology stocks may be a consequence of the popularity of indexing. All but Apple trade at valuations in excess of the S&P 500 Index. As some may say, the trend is your friend; however, when trend changes it can turn against an investor quickly.

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