Appetite may be tested sooner rather than later, according to analysis from UBS Group AG. Immediately after a jump in choppy market conditions, momentum tends to outperform, the bank said. Then, about 45 days after a VIX shock, cheap stocks typically catch up and momentum struggles. True to form, momentum delivered market-beating returns following the February VIX spike. As such, volatility patterns of yesteryear suggest the strategy may be near a turning point, equity analysts warned in a Wednesday note.
Whether a new regime is brought on by shifting technology demand or economic concerns feeding appetite for defensive shares, the result is the same: momentum would initially plunge amid a leadership change. Still, the model would eventually readjust to the latest trading pattern, remaining a viable investing style in the process -- likely backed by large pools of money.
For now, that may be an academic point. In fact, momentum gained on Friday, helping to erase losses from earlier in the week. Risks are rising and there are few alternatives. Higher interest rates hurt bond proxies, bad-balance sheets dog cheap stocks and lofty valuations haunt companies with strong earnings growth, pushing investors to the momentum trade by default, said Andrew Lapthorne, global head of quantitative strategy at Societe Generale AG.
These dynamics create "extreme markets similar to 1999, where investors buy tech because their downside risk is unknown and as an aversion to problems elsewhere,” he said in an interview. “While aggregate valuations are not as bad, individual valuations are, and of course, the tech sector is huge now as a percent of GDP. Tech inevitably will be more cyclical than investors assume.”
This article was provided by Bloomberg News.