The 2 Most Powerful Forces In Markets

Momentum and Mean Reversion.

The two most powerful forces in markets.

Momentum dictates that what has done the best in the past will continue to do the best and Mean Reversion just the opposite – where what is done the worst will eventually do the best, reverting back to its mean.

That both can be true is one of the great paradoxes in investing.

After the pandemic began last year, we saw one of the most epic momentum runs in history. Many of the leading stocks and sectors (particularly in technology) heading into the pandemic would see their trends accelerate to the upside when the shutdowns began in last April.

This resulted in significant outperformance among leading stocks, with the highest momentum names showing the most outperformance.

You can see this play out in the chart below, which illustrates the returns of 3 ETFs from the start of 2020 through February 12 of this year. The concentrated momentum ETF ($QMOM, 50 positions) was up 107% versus 43% for the diversified momentum ETF ($MTUM, 125 positions) and 24% for the S&P 500 ($SPY, 500 positions).

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Then, without any notice, the trends stopped. Since February 12, we’ve witnessed one of the sharpest momentum reversals ever, with the S&P 500 gaining 1% while diversified momentum ($MTUM) declined 12% and concentrated momentum fell 28% ($QMOM).

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On a relative basis, this reversal has wiped out most of the gains since the start of 2020 for diversified momentum ($MTUM vs. $SPY) and 8 months of gains for concentrated momentum ($QMOM vs. $SPY).

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While momentum has been getting crushed, these have been the best of times for mean reversion, where previously beaten-up stocks and sectors have been outperforming by a wide margin.

The 25 stocks in the S&P 500 with the lowest returns last year are all positive to start the year, with a medium return of +32%.

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Disclaimer: All information provided is for educational purposes only and does not constitute investment, legal or tax advice, or an offer to buy or sell any security. For our full ...

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