SUPERNEWS

Macro

Momentum Stocks' 13ppt Surge Risks Sharp Correction: MacroScope

Momentum stocks at risk of correction amid inflation pressures, with a 13-point quarterly outperformance signaling potential downturn.

By Barry Stearns

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4/9, 04:02 EDT
S&P 500
iShares 20+ Year Treasury Bond ETF
iShares 7-10 Year Treasury Bond ETF
Broadcom Inc.
Meta Platforms, Inc.
NVIDIA Corporation
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Key Takeaway

  • Momentum stocks' extreme outperformance signals a high risk of correction, with historical data showing negative returns when quarterly outperformance exceeds 10 percentage points.
  • Record high crowding in momentum stocks and hedge funds' tilt towards momentum could lead to severe market corrections if trends reverse.
  • Rising inflation and the upcoming US CPI data could trigger a sell-off in tech-heavy momentum portfolios, exacerbating potential market corrections.

Momentum Stocks at a Crossroads

Momentum stocks, having led the charge in the current rally, are now facing a critical juncture. With their performance reaching levels not seen in over 30 years, the risk of a significant correction looms large, particularly as inflation pressures mount. The MSCI’s momentum factor's quarterly outperformance stands at a staggering 13 percentage points, a level historically associated with negative returns in the ensuing months. This extreme outperformance, coupled with record high crowding in momentum stocks as noted by JPMorgan and a record tilt towards momentum in hedge-fund portfolios according to Goldman Sachs, sets the stage for a potential sharp reversal.

Inflation and Yields: A Double-Edged Sword

The rally in momentum stocks has occurred amidst rising real yields, a situation that typically would dampen equity market performance. However, momentum stocks have shown a high beta-and-correlation combination to changes in US 10-year real yields, allowing them to thrive even as yields climbed. This unusual dynamic is at risk of unraveling should inflation re-accelerate, posing a significant threat to tech-heavy momentum portfolios. With the US CPI data for March on the horizon and leading indicators pointing towards a resurgence in inflation, the market may be ill-prepared for the impact on high-duration tech firms like Nvidia, Meta, and Broadcom.

Liquidity Concerns and Hedging Strategies

The equity market is also navigating potential short-term liquidity headwinds, with the Treasury General Account's rise in the second half of April expected to temporarily remove market liquidity. While this may not derail the bull market, given the low recession risk and supportive excess liquidity, it underscores the importance of cheap equity hedges. Strategies such as VIX call options, short credit, and bond volatility are highlighted as prudent measures to mitigate potential market downturns.