What Happened to Momentum Last Week?

What recently occurred in U.S. financial markets is nothing short of extraordinary when viewed through the lens of factor investing. While on the surface it appeared as if all were calm for the five trading days from September 4-September 10 with the S&P 500 Index rising by 2.56% and the Russell 2000 Index (small cap stocks) rising by almost 5%. Underlying this performance, however, were significant factor moves, at largely unseen levels of volatility, since the Great Financial Crisis in 2008-2009.

So, what are factors and what is “factor-investing?”

Broadly speaking, factors are characteristics in the market that can explain differences in stock returns— and stocks have varying levels of exposure to such factors. Some of the more prominent factors include value, growth, momentum, market capitalization and beta. As a given factor performs better or worse, stocks with exposure to those factors generally follow suit.

Recently, the massive moves in factor performance for these five trading days (i.e., September 4-September 10), caused a stirring undercurrent that is worth discussing. Given we have a strategy that is highly focused in the small cap market within the U.S., the data below is from our investable universe of small cap stocks (as we screen out stocks based on liquidity, analyst coverage or lack thereof, and price). Much of what occurred can be viewed through the below chart:

Factor Returns: Decile 1 versus Decile 10

Data from 09/04/19-09/10/19
Factor Returns | 361 Capital
Source: 361 Daily Factor Returns Models, S&P Global Services. MTM = Medium-Term Momentum, STM = Short-Term Momentum, Mkt Cap = Market Capitalization, Prc Chg Vol = Price Change Volatility, Beta = Beta

What stands out in the chart are the two momentum metrics, along with market capitalization to the downside, and volatility and beta to the upside. Momentum, while generally a positive force for stocks over the medium- and long-term, is a volatile factor and can move decisively negative over shorter periods of time. Analyzing stocks in relative terms helps frame the scale of the negative move in momentum. Breaking down our investable universe into deciles (e.g., if we had 100 stocks, each decile would consist of 10 stocks, with the highest/most exposed stocks in decile 1 and the opposite in decile 10) and comparing the relative performance of those deciles demonstrates a telling tale.

Specifically, we saw a -11.4% performance spread in just that five-day period for medium-term momentum within our Russell 2000 research universe. Therefore, any manager that was exposed to momentum, or focused exclusively on momentum stocks had a very difficult period. This performance was not exclusive to the small cap market, as U.S. large caps saw similar volatility in factors. In fact, September 9 was the single worst day we have measured for medium-term momentum since the Financial Crisis for both U.S. Small Cap stocks and U.S. Large Cap stocks:

Factor Performance: Large Cap versus Small Cap

Data from 09/04/19-09/10/19

Russell 1000Russell 2000
MTM-11.7%-11.4%
STM-8.4%-5.1%
Mkt Cap-7.9%-8.7%
Prc Chg Vol9.0%7.3%
Beta8.4%8.5%

Source: 361 Daily Factor Returns Models, S&P Global Services.

On a market capitalization basis, the largest companies severely underperformed smaller cap peers (again, viewing it through the decile 1 versus decile 10 lens). The spread between those was roughly 9%. What this means is that the largest companies within the Russell 2000 Index universe handedly underperformed. Therefore, investment strategies skewed to larger companies most likely struggled relative to the market, and in particular, to other managers that focus further down the market cap spectrum.

Viewing the market through a beta lens, that is, how much exposure does a stock have to the market (e.g., a beta of 1 means a stock will move in lock-step with the market, while a beta of 1.5 would suggest a stock would move 50% more, either up or down, than the market) is also worth discussing. Again, leaning on our decile framework, those stocks that had the highest beta to the market versus those with the lowest beta, handedly outperformed in the five trading days by almost 9% within our small cap research universe. Essentially, investors were significantly rewarded for taking risk (if viewing beta as “market risk”). Those more defensive in nature most likely lagged to a large degree.

While we have seen moves in these factors similarly in the past, it has been more than a decade. Not only were the moves large, but the speed at which they occurred was staggering (i.e., the volatility and velocity of the swings was significant). As mentioned, these periods tend to be short-lived but depending on where one has exposure (e.g., decile 1 or decile 10, or somewhere in the middle) and how much (i.e., leverage), could have resulted in significant outperformance/underperformance in a very short period of time.

Read our related blog post, What the F@#%ctor? >