Growth & Momentum Are Now Reverting

Last week, we discussed how Growth and Momentum are both overbought in our normalized return framework, and urged caution to managers who are long exposure to those factors (most notably Tech investors). This week, we have an update on how these factors have trended (spoiler alert: Momentum is now reverting) and see what we can learn from historical instances when Growth and Momentum have reverted concurrently from similar heights in the past.

Before we dive in, let’s take a look at the past week's market and factor action:

‍US Market (6/7/19 - 6/13/19)

• After drifting upwards over the week, the S&P 500 closed slightly down on Friday (not captured in above chart), along with the other major indices.
• All eyes are on the Fed next week as investors face trade uncertainty and heightened geopolitical risk in the wake of US accusations that Iran was responsible for the attacks on two oil tankers in the Gulf of Oman.
• U.S. factory production expanded in May, up 0.2% after being down -0.5% in April, according to Fed data. This was the first positive move since December of last year, suggesting resilience in the manufacturing sector despite trade headwinds.
• US retail also showed broad-based gains, with sales up +0.5% over April. The combination of the manufacturing and retail data suggested to some that a Fed rate cut might not be as imminent as the market had anticipated.
• Meanwhile, tech stocks (chipmakers in particular) took a hit on Friday after Broadcom guided down citing weakness in global demand.

Here's an update on how some key factors (and US Total Risk) have changed in the US model over the past week, using our normalized return indicator:

• Profitability was the biggest winner, up +0.45 standard deviations since last Thursday. Meanwhile, Earnings Yield saw a very slight decline and has officially entered Oversold territory.
• Size continued to rally back from its recent trough of -1.76 SD below the mean on 6/3/19, up +0.41 SD and shedding the Oversold tag now that it’s back within less than -1 SD below the mean.
• Volatility and Market Sensitivity both enjoyed positive moves on a normalized basis as they rebounded from deeply Oversold designations back towards Neutral.
• US total risk (using the Russell 3000 as proxy) ticked up from 13.62% on 6/3, cresting at 14.06% on 6/10, and has started to trend back down...currently sitting at 13.93%.

‍Growth Has Reverted Back To Neutrality

In last week’s Factor Spotlight, we outlined how Growth in the US model had seen a steep rally over the past couple of months, peaking at +1.09 standard deviations above the mean on 5/31 (we note Growth had peaked at +1.85 SD in the Global model). It has since reverted at a decent clip, falling -0.23 SD’s in the past week alone, now sitting at 0.66 SD above the mean (Neutral). As a reminder, Growth factor is a blend of sales growth, estimated sales growth, earnings growth, and estimated earnings growth. If we take a look at the past 12 months of returns, we can see what the reversion pattern has looked like compared to what we’ve seen over the past few days.

Medium-Term Momentum - Far to Fall

‍This factor had seen an even more improbable run-up on both a cumulative and normalized basis, and appears to have just peaked on 6/10/19 at an astronomical +2.79 SD above the mean. There have been few occasions since the beginning of the model lookback period (1/1/2007) when Momentum has come close to these heights. In fact, there has only been one instance where normalized returns were higher than +2.79 SD, a stretch in July 2015 when returns hit +3.49 SD above the mean (7/20/15). We’ve now seen a reversion in this factor over the past three days, with normalized return falling to +2.71 SD above the mean on 6/13/19.

Medium-Term Momentum is defined simply as cumulative return over the past 12 months, excluding the most recent month.

Historical Concurrent Reversions

‍We took a look through historical data to achieve an understanding of how Growth and Momentum have behaved in the past when reverting from similar heights as the ones they’ve reached in the past few weeks. Since Jan 2007, there have only been three periods where Growth was 1+ SD above the mean and Momentum was simultaneously 2+ SD above the mean. Below are charts showing how each factor behaved in the three months after hitting those thresholds.

‍10/20/08 - 1/20/09

‍In the weeks after the market crash at the end of September 2008, Momentum and Growth were flagged as Extremely Overbought and Overbought, respectively, both correlated with the Oil & Gas sector (in particular: IEO and XOP). On 10/20/08, Growth sat at +1.36 SD above the mean and Momentum was at +2.13 SD above the mean. By 1/20/09, Growth had fallen to -0.33 SD below the mean and Momentum had plunged to -2.03 SD below the mean.

2/27/18 - 5/27/18

‍We had to wait almost a full decade later until these thresholds (Growth 1+ SD above the mean, Momentum 2+ SD above the mean) were triggered again (now most correlated with the Semiconductor (SOXX) and Software industries (IGV)). After the market sharply fell to a bottom on 2/9/18 and subsequently rallied, Momentum hit +2.01 SD above the mean on 2/27, while Growth sat at +1.62 SD above the mean on that date. Over the next few months, each factor reverted, with Momentum bouncing off a bottom of -1.01 SD below the mean on 5/1/18, and Growth continuing to drift downward (sitting at -1.36 SD below the mean on 5/25/18).

12/27/18 - 3/27/19

‍Even more recently, these factors hit the stated thresholds at the end of 2018, and saw a similar pattern to the previous regime - Momentum reverted to a deep bottom of -1.71 SD below the mean on 2/20/19 and then started to bounce back, while Growth drifted further down into Oversold territory.

‍Medium-Term Momentum - Normalized Return

Growth - Normalized Return

Conclusions

‍As we continue to watch both Growth and Momentum fall away from their most recent peaks in early June, history suggests that a sustained and concurrent reversion is in store for both. We might also expect to see Momentum recover from a bottom quicker than Growth. One last item to note is that of the four instances when Growth and Momentum surpassed the +1 and +2 SD thresholds at the same time, three of them have happened in the past 16 months. These trends are important to follow, particularly if your portfolio has considerable exposure to either or both of these factors.

Regards,
Omer