Is chasing momentum stocks a good bet at market peaks?
Amid a runaway stock market, momentum has outrun almost everything else. Over the past five years, the Nifty200 Momentum 30 index has clocked 25.7%, compared to 17.4% by the Nifty 200 index. The underlying strategy of chasing recent winners has worked like a charm, but can pursuing outperformers continue to reward investors even at historic market peaks?#sr_widget.onDemand p, #stock_pro.onDemand p{font-size: 14px;line-height: 1.28;} .onDemand .live_stock{left:17px;padding:1px 3px 1px 5px;font-size:12px;font-weight:600;line-height:18px;top:9px} #sr_widget.onDemand .sr_desc{margin:0 auto 0;} #sr_widget.onDemand .sr_desc{color: #024d99;margin-top:10px;} #sr_widget.onDemand .crypto .live_stock .lb-icon{8px 6px 5px 3px !important} #sr_widget.crypto.onDemand a.text{border-bottom:1px solid #ccc;padding-bottom:5px;display:block;width:100%} #sr_widget.onDemand .sr_desc .text p, #stock_pro.onDemand .sr_desc .text p{font-size:12px;font-weight:400;} Any lingering doubts about momentum investing—‘buy high, sell higher’ strategy—have been laid to rest in the past few years. This stellar showing has occurred in a period marked by a near-uninterrupted, one-way rise in the stock market. Consequently, many investors have piled on to the momentum trade, expecting a free lunch. However, after this breathless run, experts reckon that investors need to recalibrate. All investing strategies swing between extremes over long periods, and momentum is no exception. Anish Teli, Managing Partner, QED Capital Advisors, insists, “After such sharp outperformance, some mean reversion is to be expected.”
If you are not playing your cards right, momentum can be a double-edged sword. When the tide turns, momentum can prove to be very painful on the downside. “If you are new to the momentum strategy and have not previously been exposed to it, now may not be the best time to test the field,” contends Anoop Vijaykumar, Fund Manager & Head of Research at Capitalmind, a Sebi-registered PMS that runs a momentum portfolio.
Momentum investing: Outcomes vary with market conditions
The strategy works differently at market peaks and in normal times.
![im-1 im-1](/uploads/2024/07/15/the-investing-strategy-has-been-successful-in-recent-years-but-it-may-be-time-to-recalibrate-0.jpg)
As data from Capitalmind shows, playing momentum is a different experience under different market conditions. Between 2006 and 2024 (year-to-date), the Nifty200 Momentum 30 index has traded near market highs (within 5% of peak) 36% of the time. Away from market peaks, the index has exhibited negative one-year forward return 17% of the time. However, while trading near market peaks, this rises to 27.5%. Near market lows (within 10% of 52-week low), the probability of negative one-year forward return from the momentum index falls dramatically to 1.5%.
This does not imply that momentum is necessarily risky at market peaks. In fact, the one-year forward return from the momentum index near market peaks has averaged a healthy 18.3%, moderating only slightly from 22.6% at other times, shows the data from Capitalmind. Experts contend momentum can be played in different ways and specific brands of momentum investing tend to work better in certain market conditions. Among other things, the period chosen for capturing price trends, the frequency of rebalancing the portfolio and use of additional overlaying filters can distort outcomes. This is where the index-based momentum strategies differ from corresponding actively managed mutual fund and PMS offerings. The Nifty200 Momentum 30 index identifies stocks based on six-month and 12-month price strength and rebalances the portfolio half-yearly. Some active momentum strategies combine one- or three-month and six- or 12-month price trends with monthly or quarterly rebalancing. A few like Samco Active Momentum hedge positions in weak market phases to minimise impact of market falls.
In falling or weak markets, a faster reset of portfolio can mitigate the ‘signal decay’ that momentum investing is typically exposed to. This is the risk that the portfolio will not be able to exit stocks before the price strength dissipates or correction becomes acute. Teli argues, “When rebalancing is faster, the quality of signal is better. If market trends change, a slower rebalance will occur much later, which will leave the portfolio exposed to a hit for that much longer.” Various studies have also shown that slower rebalancing is prone to suffer more around market turning points on the downside. Vijaykumar concurs, “Every back-test we have run has shown that monthly rebalancing is the gold standard to mitigating the impact of price reversions in a momentum strategy.”
However, pre-empting market declines is very tricky, so changing tacks on a whim is futile. There are other ways in which momentum can be exploited safely despite prevailing market conditions. Teli remarks, “It may be a good idea to extend your investing time horizon beyond five years. The momentum effect is proven to be among the strongest factors in the long run as it eventually builds exposure to the market pockets doing well, behaving like a chameleon.” Currently, momentum portfolios are skewed towards the value basket as well as mid and small caps, which have ruled the charts in the recent past. As market preferences shift going forward, possibly towards defensives and quality stocks, the momentum portfolio will also reflect the changed market stance.
Vijaykumar suggests diversifying across market segments within the momentum basket to mitigate any price damage in a few pockets. He also suggests keeping allocation to momentum within risk tolerance zone. The investors who have previously seen how momentum works across market cycles should stay the course. “Investors should now moderate return expectations and focus on risk management even while pursuing momentum,” Vijaykumar adds.
Complementing momentum with other factors can offer a smoother ride. For instance, momentum or alpha, combined with low volatility or quality, has delivered better risk-adjusted return in the past. ETFs based on indices like Nifty Alpha Low Volatility 30 can offer a better risk-return proposition as the market enters an uncharted territory. The upcoming Edelweiss Business Cycle Fund will harness momentum, with other factors like growth, quality and value, to rotate between trending sectors dynamically.
#sr_widget.onDemand p, #stock_pro.onDemand p{font-size: 14px;line-height: 1.28;} .onDemand .live_stock{left:17px;padding:1px 3px 1px 5px;font-size:12px;font-weight:600;line-height:18px;top:9px} #sr_widget.onDemand .sr_desc{margin:0 auto 0;} #sr_widget.onDemand .sr_desc{color: #024d99;margin-top:10px;} #sr_widget.onDemand .crypto .live_stock .lb-icon{8px 6px 5px 3px !important} #sr_widget.crypto.onDemand a.text{border-bottom:1px solid #ccc;padding-bottom:5px;display:block;width:100%} #sr_widget.onDemand .sr_desc .text p, #stock_pro.onDemand .sr_desc .text p{font-size:12px;font-weight:400;}
This story originally appeared on: India Times - Author:Faqs of Insurances