Momentum Crash
In our reports in December and January, we called for Momentum assets to underperform Value assets. We argued that this will happen on account of record valuation spreads, and record level of position crowding across many types of investors. We believed a convergence of central bank policies and macro trends across the globe, and Q1 seasonality, could serve as likely catalysts for this reversal. As a part of this convergence trade we called for higher prices of Oil, Gold, Emerging Markets and Value stocks, and lower prices for momentum assets such as USD or momentum stocks. These moves started to materialize, with Value assets outperforming momentum assets, on average by ~15% YTD (e.g. see the table of 30 momentum and value assets in our Outlook and our last update). In addition to this asset allocation view, we have argued for a sharp pullback of Momentum stocks (e.g. Momentum long-short portfolios, see here and here) which we identified as being in a ‘Macro-Momentum Bubble’. The crash of the Momentum long-short portfolio happened in early February and again in early March with outperformance of Value over Momentum long-short portfolios of ~40% YTD (see figure below). To put this in perspective, March 2nd to 7th the momentum portfolio sold off for 4 consecutive days by 4, 4, 3, and 4 standard deviations (resulting in a weekly move of 6 sigma). This was followed by a one-day 7 sigma momentum bounce back, but this still left momentum stocks down more than 20%
for the year, and 40% behind value portfolio. This move was comparable to the quant meltdown in August 2007 (starting 8/8/2007, the momentum long-short portfolio sold off by 5 and 4 standard deviations in 2 consecutive days, followed by a 6 standard deviation bounce-back). While we know that returns of quant portfolios are far from normally distributed, the early-March factor returns are extraordinary large. Figure 1 below shows daily returns (in standard deviations) of a momentum portfolio YTD. Once can see early February moves (4, 3, and 2 sigma, and a 4 sigma bounce), as well as early March moves (4, 4, 3, 4 sigma, and a 7 sigma bounce).