Momentum Investing: The Market Beating Strategy

What is momentum investing? Buying assets trending upwards in price while selling those trending downwards — i.e. buying the strongest parts of the market. To make investors’ lives easier, momentum ETFs were created with a momentum strategy.

ELI5: What is an ETF?

Here’s the problem: These purchases would often be delayed. In most cases, momentum ETFs rebalance (i.e. add/sell positions) every 4 or 6 months.

• Since the end of 2020, stock market momentum shifted from growth to value stocks.
• But many of these momentum ETFs purchased these value stocks in recent months — with little upside.

For this reason, the largest momentum ETFs underperformed in the past month. But when we compare investments, we have to look at a longer timeline.

History tells a different story: In the past 8 years, momentum ETFs beat the market average returns of the S&P 500 — 159%:

• 258% return by the iShares MSCI USA Momentum Factor ETF (BATS:MTUM).
• 234% return by the Invesco S and P MidCap Momentum ETF (NYSE:XMMO).

According to a report by Aviate Global, momentum stocks have two different periods when it underperforms the market:

• When the market crashes — momentum ETFs underperform on the way down.
• When the market recovers after a crash — momentum ETFs underperform near the beginning of the bull market/recovery

In the pandemic case, check and check. Momentum stocks underperformed on the way down and in the past year as the market recovered.

If we follow history, it may be time for momentum stocks to outperform again.