Momentum trade unravels as S&P 500 Momentum Index falls 9%

The S&P 500 Momentum Index has fallen more than 9 percent since July 1, trailing the S&P 500's 2.8 percent gain as momentum unwinds.

"It is a self-fulfilling prophecy," said Matthew Tym, managing director at Cantor Fitzgerald, describing the momentum trade that had rewarded investors for years.

The momentum index soared 44 percent in the second quarter, its best quarterly performance on record, and surged 133 percent over the past five years — nearly double the broad market's gain. July was the second-worst month for the momentum trade in roughly 40 years, according to Bank of America estimates, with only April 2009 worse. Hedge funds that bought momentum shares while shorting low-momentum stocks suffered the most, and Goldman Sachs' basket of the most popular hedge fund holdings recorded its biggest one-month underperformance in more than two decades.

The reversal has pushed speculators' net short positions in Nasdaq-100 futures to some of the highest levels in two decades, according to Commodity Futures Trading Commission data, threatening to amplify volatility in large-cap technology and AI stocks as hedge funds deleverage.

The momentum trade rests on a simple observation: investments that rise tend to keep outperforming, while laggards often stay behind. For decades, the strategy paid off. "It didn't take a lot of sophistication to run a momentum strategy and make a decent living at it," said Agustin Lebron, senior researcher at EquiLibre, a trading firm. The persistence of momentum partly reflects how slowly information spreads across investors, he said. "A huge pension fund can't flip around its positions in a day. Behavioral biases also account for some of the effect — people tend to sell their winners too early and hold losers too long."

The unraveling accelerated this month. Moderna shares surged roughly 150 percent after positive news on a cancer vaccine developed with Merck, crushing quant and hedge funds that had heavily shorted the biotech stock. On Aug. 19, Goldman Sachs told clients it was the worst day for "systematic long-short managers" in more than two years, with about half of the losses tied to momentum trades.

The pain has spread beyond quant funds. Situational Awareness, a hedge fund that had piled into popular momentum shares including chip stocks, collapsed during the market tumult. Nvidia shares then rocketed almost 9 percent after its earnings, showing how quickly positioning can shift.

Some investors see echoes of the dot-com era in the run-up in technology shares. Mike Ogborne, founder of San Francisco-based Ogborne Capital Management, said he has grown more cautious on technology stocks and is holding more cash than usual, nervous about rising capital expenditures from technology giants. "It is a little bit like Cinderella and the clock striking midnight," Ogborne said. "You don't know when midnight is going to come around."

Fans of the strategy remain believers. "Any strategy has disappointing periods," said Antti Ilmanen, global co-head of the portfolio solutions group at AQR Capital Management, noting that some of the worst months for momentum strategies have occurred during longer periods of outperformance.

This article is for informational purposes only and does not constitute investment advice.