Momentum funds draw buy-the-dip buzz after July stumble

Momentum stocks have hit an air pocket in July, and MarketWatch columnist Brett Arends says that is exactly why some long-term investors may want to look again.

Arends pointed to the iShares MSCI USA Momentum Factor ETF, ticker MTUM, which he said has lagged the Vanguard Total U.S. Market ETF, ticker VTI, by 8.5 percentage points since the end of last month. Since momentum strategies peaked about a month ago, he said the gap has reached 10 points. Through last Thursday, when momentum appeared to hit a relative low, MTUM had trailed VTI by 12 points this month.

Momentum investing usually means buying stocks that have already been strong performers over the prior three to 12 months. The catch is plain: the strategy can suffer sharp reversals when former winners suddenly fall behind the broader market.

Arends argued that, for investors who accept the long-term data behind momentum, those ugly patches can be more opportunity than warning sign.

What the research says

A recent academic review by Guido Baltussen, M. Sipke Dom, Bart Van Vliet and Milan Vidojevic of the Erasmus School of Economics in Rotterdam and Northern Trust Asset Management described momentum as a core factor in equity markets.

The researchers wrote that evidence for momentum spans domestic and global stock markets across as much as 150 years of data. In the U.S., they found momentum results going back to 1866, with the highest-momentum stocks beating the lowest-momentum stocks by an average of 9 percentage points a year.

The paper said the top 20% of U.S. stocks by momentum beat the bottom 20% by an average of 11 percentage points annually from 1965 to 1989. From 1990 to 2024, the spread was 7.9 percentage points. Across 31 international markets since 1990, the researchers found similar patterns, with Portugal showing the strongest momentum effect and Japan the weakest.

For that study, momentum was measured by a stock’s price move over the previous 12 months, excluding the most recent month.

Arends noted that the recent paper follows decades of work on the subject, including influential 1993 research by Narasimhan Jegadeesh and Sheridan Titman, then finance professors at UCLA’s Anderson School of Management.

The fund numbers

MSCI data cited by Arends show that since the end of 2000, its standard U.S. stock index has produced total shareholder returns of 815%. MSCI’s U.S. momentum index returned 1,395% over the same period, which Arends described as about 70% more than the broad index.

He also cited the Invesco S&P Midcap Momentum ETF, ticker XMMO, launched in early 2005. A $10,000 investment at launch, held in a tax-sheltered account with dividends reinvested, would now be worth $120,000, according to Arends. The same investment in State Street’s S&P 400 Midcap SPDR, ticker MDY, would be worth $73,000.

XMMO returned about 11.4% a year on average, compared with 9% for the midcap index, he said.

Since BlackRock’s iShares launched MTUM in 2013, Arends said it has returned 16.2% a year on average. That compares with 14.4% for the S&P 500 SPDR, ticker SPY, and more than two percentage points ahead of the broader U.S. market as represented by VTI.

The nasty part

Arends’ review of MSCI data going back to 2000 found 11 momentum reversals of at least 5% before the current one. On average, they lasted 7.7 months and saw momentum trail the standard index by 11%.

Six prior reversals involved underperformance of 10 percentage points or more. The worst came during the global financial crisis, lasting 19 months from 2008 through 2010 and producing 22% underperformance, according to Arends.

His conclusion: investors still have to decide how much, if anything, belongs in momentum funds. But for those who already believe momentum will keep working over time, he says a reversal like the current one may be a better entry point than a reason to run.

This story draws on original reporting from MarketWatch.