Market leadership change and momentum investing

Written by Minich MacGregor Wealth Management on March 29, 2016. Posted in Minich MacGregor Missive, News.

Market leadership change and momentum investing

Investopedia defines momentum investing as:

“Momentum investing is an investment strategy that aims to capitalize on the continuance of existing trends in the market. The momentum investor believes that large increases in the price of a security will be followed by additional gains and vice versa for declining values.”

One of the key pieces of data needed to implement a momentum strategy is knowing which sector is outpacing the pack. The good news is once leadership is established they often stay leaders for a fairly good stretch of time. For example, biotech and healthcare had been consistent leaders over the past several years. The bad news is momentum investing can be, shall we say, frustrating when there is a change in leadership. It is a waiting game where unbiased data analysis is intensive but action is slow. It is a period where the proverbial “head fake” is common and you have to count on being wrong some of the time which is often frustrating for investors that do not have a well thought out, written investment strategy.

Closely related to momentum investing is trend analysis. A trend is really nothing more than the general direction in which a security or market is headed. That direction can be one of three directions – up, down or sideways. During a leadership change, trend lines for various sectors are often sideways until one or more of the sectors break out of that trend and establish new leadership.

Momentum investing predictably goes through a period of underperformance during these changes in leadership or sideways trends. However, over time, momentum strategies executed with discipline often outperform their buy-and-hold strategy counterparts during periods of growth as well as decline.

So where are we now? Although there are some promising signs for new leaders, by most definitions, we are still in a fairly sideways trend in the equities markets. We are watching for the next leaders to emerge and settle in, knowing there will be some “head fakes” along the way.