There’s been a bumper crop of US stocks that are up triple digits this year. With those kinds of gains, momentum strategies—essentially where traders bet that whatever is rising will continue to rise, and vice versa—can also produce gains. At the same time, the performance of momentum can be seen as a market indication of extremes.
Philip Straehl, chief investment officer, Americas at Morningstar Wealth, points to recent returns on the S&P 500 Momentum Index. From April through May, the index returned 34%, its strongest two-month period in more than three decades. “The last comparable surge occurred in late 1999, near the peak of the internet bubble,” he notes.
Straehl says that for investors, the implication is that what goes up fast can come down further. “Our research suggests that periods of strong momentum acceleration increased the likelihood of a reversal,” he says. “While every market cycle is different, periods of exceptionally strong momentum have often coincided with elevated investor optimism and speculative behavior. Although this may not signal an imminent reversal, it serves as a reminder that parts of the market may be pricing in highly optimistic outcomes. In this environment, we believe a more selective approach is warranted.”
