The momentum trade that has worked extremely well so far in 2015 is reaching a turnaround point, Citigroup analysts warn.
Investors who've been minting money according to the Wall Street adage that the trend is your friend just got a reminder that nothing works forever.
A Citigroup Inc. index that tracks U.S. momentum stocks like Apple Inc. and Netflix Inc. did something last week it hadn't done since June — it fell. While still trouncing the S&P 500 in 2015, analysts at the bank have warned that the strategy is approaching a threshold where rotations have occurred in the past.
Virtually nothing has worked better in this year's thinning equity market than momentum, where you load up on stocks that have risen the most in the past two to 12 months and hope they keep going up. Sent aloft by sustained rallies in biotech and media shares, concern is mounting that the trade has gotten too popular, setting the stage for sharper swings.
"In the past few years, including this year, there have been a lot of moments when trades have become crowded," said Arvin Soh, a New York-based fund manager who develops global macro strategies at GAM, which oversees $130 billion. "What's different is that the reversals that eventually come do tend to be more severe now than what we've seen over a longer-time horizon."
With breadth narrowing before the Federal Reserve raises rates, sticking with winners has been a blueprint for success in 2015. Quantitative funds were among the best performers out of equity, event-driven and macro strategies through July this year, trailing only technology, health-care and activist managers, according to data by Hedge Fund Research Inc.
INDIVIDUAL INVESTORS HAVE NOTICED
Individual investors have noticed. One of the largest exchange-traded funds employing the tactic, the iShares MSCI USA Momentum Index Fund, lured a record $125 million in July, boosting its total by about a fifth. It hasn't had a single month of outflows since it started in 2013.
Owning it has paid off, too: the fund is up 8.2% in 2015, compared with 1.8% in the S&P 500. Another ETF, the Powershares DWA Momentum Portfolio, recently saw assets cross $2 billion and has returned more than 7% this year. Still, some of the trades contributing the success have been weakening.
Since July, industry leadership in the S&P 500 has been shifting, not what momentum investors want to see. Utilities are leading the market since August and last year's winners, health-care and consumer companies, are trailing. The Newedge CTA Index, which tracks computer-driven strategies and funds that place wagers on broad economic trends, has fallen 6.5% from a high in April.
Even Apple, the company that has contributed more to the U.S. bull market than any other company, is faltering. After the iPhone maker's 10-fold surge since 2009, shares have tumbled 12% from an all-time high in February.
Investors are suddenly paying more attention to companies in better financial shape with less debt — qualities that have been absent in recent momentum winners such as biotechnology. In July, a Goldman Sachs Group Inc. gauge that tracks equities with the strongest balance sheets reached its highest level versus stocks with weaker ones since October 2013.
Because of the heavily correlated nature of momentum trades, selloffs can be sudden as everybody exits together, according to Nicola Marinelli of Pentalpha Capital Ltd. That raises the stakes for traders who will return from vacation just before the Fed meets on Sept. 17.
"There can be a reversal and it doesn't necessarily need a catalyst," said Mr. Marinelli, a fund manager who helps oversee 114 million euros ($126 million) of assets at Pentalpha in London. "In August, very few big players are going to make big decisions regarding their portfolio. If something happens, it's going to be more September, October."
BIOTECH COULD BE AT RISK
The surge in biotechnology shares may be at risk given concerns about pricing on some drugs, according to Hugh Grieves of Miton Group. The Nasdaq Biotechnology Index has underperformed the S&P 500 this quarter, after beating it for five years.
"The question is whether you're seeing the narrative change around biotech and it's causing that momentum trade to lose steam," said Mr. Grieves, a London-based portfolio manager at Miton, who runs the firm's U.S. Opportunities Fund. "The problem with momentum trades is that you have no margin of safety. When you get on the bandwagon, you shut your eyes to valuation."
