Skip to main content

Factor Battle

September 10, 2019

Over the last two trading sessions, there has been a lot of buzz around the performance between two "corners" of the market. However, these are not stocks in a specific sector or industry, but instead, we are talking about the returns among factors. And two factors in particular: Momentum ($MTUM) and Value ($RPV $SPYV).

If you are unfamiliar with factors, here is a great piece of the concept of the five major factors in investing. And more specifically, Momentum and Value as a combination, which is very popular among some quantitative investors. More on that later.

Since Monday's open, Momentum was down over 4% at its lowest point. Meanwhile, many Value-focused funds have been up 3-4%. Individual stocks have fared even better, with many Energy names substantially higher.

To get things started, Momentum and Value appeared at opposite ends of the spectrum as of Monday's close.

And then going into Tuesday, we saw further breakdowns of a more technical nature.

As you can see from Mark Newton's chart, the intermediate trend in the relationship (dating back to late 2018), has been broken, in favor of Value.

What has caught so many off guard is the swiftness and magnitude in which the reversal has occurred.

As you can see from Paul Kedrosky's visual, the spread between the two is closing quickly.

Bespoke wrote a note today explaining that yesterday was the largest one-day percentage drop for $MTUM/$VLUE in years.

And from a longer-term perspective, Charlie Bilello points out that the relationship between these two factors recently reached another extreme, and is now reverting.

Brandon Van Zee of Market Scholars also notes that not only is Momentum getting hit, but another factor, Low Volatility, is also feeling some pain as well.

Analysts at Nautilus Research seem to think there could be a flip to Value underway.

However, according to Wes Gray of Alpha Architect - which specializes in factor investing - this type of "chaotic" behavior is pretty normal.

I mentioned earlier that the portfolio combo of both Momentum and Value factors has grown quite popular over the years. Since the lows in 2009, the concepts of Momentum and Value have fallen on somewhat opposite extremes. Momentum has been largely tilted towards Growth stocks (i.e., Tech, Consumer Discretionary, Healthcare) throughout this period. As for Value, we typically see more Energy and Financial Services names in these funds. However, there are market environments where we can and do see overlap.

In theory, Momentum can very well become overweight in Value-oriented sectors, such as the two mentioned previously in this paragraph. And when this happens, a diversified portfolio becomes quite concentrated. A great explanation of this comes from Northern Trust Asset Management:

"The momentum factor can provide alpha and diversification, but it can also be redundant because a significant proportion of the momentum premium stems from momentum in other factors. This is commonly referred to as factor momentum and can unintentionally lead to a doubling down on factor exposure and risks in multi-factor portfolios. Skillful risk management of factors is critical to avoiding this mistake."

With the sudden reversal of fortune for the Momentum factor and a new surge in "momentum" for the Value factor, there certainly seems to be a shift taking place underneath the surface of the market. But we need to be aware of what we own. While the two may not hold similar names right now, that could change over the course of the coming weeks/months. This development is something to keep an eye on. With that said, price behavior matters most and right now, the market is telling us something according to these technicians.