Dissecting the Q3 2021 Momentum Rally

The Momentum factor tends to be top-of-mind for factor practitioners in all markets, but it has been particularly tough to take the eye off of Momentum in 2021. The last time we spotlighted Momentum, we pointed to the beginning of a transition in the makeup and characteristics of Momentum stocks. Because Medium-Term Momentum is typically a measure of a stock’s trailing twelve-month return, excluding the most recent month, we saw a seismic shift in Momentum leadership after the March 2020 downturn escaped the lookback window. This leadership change, along with a robust Q3 factor rally, has left many managers looking for answers.

Medium-Term Momentum Rally

From the beginning of the year through June, the Momentum factor saw substantial drawdowns and recoveries but ended neutral. During Q3 and Q4-to-date, however, the factor has been on a tear. Below, the Medium-Term Momentum factor in the Axioma US4 Medium Horizon model saw a 2.92% return from July 1st to October 28th. Its 2.51% return in Q3 was its highest since Q2 2019 (2.74%) and its second-highest since Q3 2015 (3.38%).

Momentum’s Significant Rotation

This Momentum rally is even more interesting because it immediately followed the rotation we saw in March and April. Before that rotation, tech stocks had reigned almost unchallenged. Since then, the economic recovery nearly entirely reversed the DNA of Momentum. Instead of the familiar growth industries, we saw value quickly take the throne. To get an initial sense of just how significant this change was, we calculated the trailing three-month correlations of the Medium-Term Momentum factor in the Axioma US4 model to the Growth and Value factors. The chart below highlights the period when Momentum took its leap from Growth to Value.

Growth managers, who have traditionally seen consistently positive exposures to the Momentum factor, and Value managers, who have usually seen the opposite, likely experienced this very change in their portfolios through Q2 and into Q3. As a result, managers expecting a helpful boost from the factor as it rallied Q3-to-Present were pushed in the opposite direction and vice versa.

What is Momentum Anymore?

To dig into the broader characteristics and discern the drivers of performance in Momentum stocks over this recent period, we built a high-minus-low (HML) portfolio for the Momentum factor in the US market. The HML portfolio is a market-neutral portfolio in which both the long and short sides are equal-weighted. Using the Russell 3000 index as a starting point, the long stocks included in the portfolio have a Medium-Term Momentum exposure > 1 and the short stocks have an exposure < -1. In addition, we screened out stocks with an Average Daily Volume of < $5m and stocks with a Market Cap of < $500m.

As expected, the first insight that jumps out is the change in industry positioning. At the end of Q1, the HML moved its tech-focused stocks from long to short and its Energy, Financials, and Real Estate stocks from short to long. The two most drastic rotations came from Biotechnology and Oil, Gas & Consumable Fuels at the industry level. Biotech went from 15.7% net long at 2020 year-end to -23% net short this week. Oil, Gas & Consumable Fuels went from -16.2% net short to 18.8% net long. These HML portfolio changes highlight the dramatic changes in Momentum exposures in these industries and illustrate the leadership shift in the factor as a whole.

What Else is Driving Momentum Stocks?

Managers running high or low Momentum exposure portfolios are also likely realizing additional systematic pressures around performance. Since we created the HML portfolio using the Axioma US4 Medium Horizon model, we decided to get a different perspective on exposures by looking through the Wolfe QES US Broad risk model lens.

Today’s Momentum DNA

The table below lists the factor exposures of the Momentum HML portfolio as of October 28th in the Wolfe QES US Broad risk model. Looking forward, we can use these exposures to understand better, directionally, what factors are likely to impact Momentum stocks.

Momentum names will move in conjunction with Profitability, Oil Prices, and Interest Rates. In contrast, they are likely to work in the opposite direction of heavily crowded stocks (long and short). Thus, managers on both sides of the Momentum fence should be cognizant of these additional forces that are likely to dictate systematic return in the near future.

Short Interest Crowding in “Anti-Momentum” Names

Short Interest can act as an additional gauge on sentiment in addition to its contribution to performance and risk. The Momentum HML portfolio experienced a 112 bp tailwind over this timeframe because the “anti-Momentum” names have a higher exposure to Short Interest. When we check the S3 Crowding Score from S3 Partners, which measures the degree of short crowding in stocks on a scale of 0-100, the short side of the Momentum HML portfolio demonstrates a markedly higher degree of crowdedness. More than 26% of the “anti-Momentum” names have scores above 60 vs. only 10% on the long side.

Between the dramatic attribute changes in the Momentum factor and the factor’s recent run, managers are likely either finding that their traditional Momentum hedges are proving ineffective or finding it difficult to identify a suitable hedge. Using Omega Point’s Security Search and Optimization capabilities, we can construct targeted and tailored baskets that target Momentum within the context of each unique portfolio.

US & Global Market Summary

US Market: 10/25/21 - 10/29/21

• All three U.S. stock market indices closed at record highs, and the S&P 500 and Nasdaq saw their best months since November 2020 as earnings reports from the country’s biggest companies overwhelmingly came in better than investors had expected, driving gains in a number of individual stocks. The positive performance came despite weak third-quarter reports from Amazon (AMZN) and Apple (AAPL).
• As oil prices continued to rise, energy companies also profited with Exxon Mobile and Chevron both reporting their third-consecutive quarterly profits of > $6 billion.
• Investors were encouraged by signs of progress among Democrats in Washington toward an agreement on a spending plan as President Joe Biden announced a framework for a $1.75 trillion social spending deal on Thursday.
• The coronavirus surge driven by the Delta variant began to fade, with the number of cases in the United States falling by more than half by the end of October.
• The Producer Price Index rose less quickly than expected in September, and the Personal Consumption Expenditures price index, which is the Federal Reserve’s preferred inflation gauge, also signaled that prices were increasing less quickly on a month-to-month basis than they did over the summer.
• A weaker-than-expected growth reported by the Commerce Department showed the U.S. economy grew at its slowest pace in more than a year this summer as a resurgence in COVID-19 infections put more strain on global supply chains, leading to shortages of goods like automobiles, which slammed the brakes on consumer spending.

‍Normalized Factor Returns: Axioma US Equity Risk Model (AXUS4-MH)

• Growth continues its recent tear to secure this week’s top spot and move ever closer to positive territory.
• Size saw sizeable gains for the 3rd straight week and broke through into the positive column to sit at +0.08 SD above the mean.
• Profitability and Earnings Yield both continued their recent upward trajectories.
• Medium-Term Momentum saw strength for the first time in 7 weeks, while on the other side of the spectrum, Market Sensitivity (Beta) fell for the first time in 9 weeks.
• Value finishes last for the 3rd consecutive week and sits on the cusp of negative territory at +.04 SD above the mean.

‍Normalized Factor Returns: Axioma Worldwide Equity Risk Model (AXWW4-MH)

• Profitability jumped upward for the 2nd straight week to finish on top of this week’s global factor leaderboard.
• ‍Size continues its recent run to sit at the cusp of positive territory at -0.01 SB below the mean.
• ‍Earnings Yield and Growth both saw another strong week moving further away from Oversold status and landing at -0.58 and -0.73 SD below the mean respectively.
• ‍Market Sensitivity (Beta) continued its trend of recent weakness to exit Overbought territory.
• Mirroring the US, Global Value dropped hard to secure a last place finish and now sits at the edge of negative territory.

Regards,
Kevin