High-momentum stocks are struggling, and that could be good news for the U.S. market as a whole. In truth, it would be more worrying if high-momentum stocks — the past year’s top performers — were soaring right now.
These high-momentum stocks tend to perform particularly well when market volatility is low, as I discussed in a recent column. They also tend to suffer during bear markets.
But how do these stocks perform in the final stage of a bull market? Could momentum stocks be a canary in the coal mine, the first to exhibit the early warning signs of a new bear market?
Many investors and advisers believe that to be true, and for that reason they are particularly concerned right now. That’s because high-momentum stocks have had it rough over the past couple of months, as you can see from the accompanying chart.
This lagging momentum has shown up in some of the previously highest-flying Wall Street darlings, as illustrated by these grim stock-price statistics:
• Netflix NFLX, -0.09% : 30% below its 52-week high
• Uber Technologies UBER, -4.05% : 31% below
• Beyond Meat BYND, -1.74% : 35% below.
• Lyft LYFT, -1.31% : 48% below
• Tilray TLRY, -2.88% : 84% below.
Anxiety-provoking as these statistics are, there actually is a silver lining. Contrary to conventional wisdom, high-momentum stocks typically do not fade as a bull market approaches its end. In fact, such stocks often produce some of their most spectacular gains in the weeks prior to the final top.
I reached this conclusion after analyzing a hypothetical portfolio constructed to always contain the 10% of publicly-traded stocks with the best trailing-year performance, reconfigured monthly. For the performance of this portfolio, I relied on data from Dartmouth College finance professor Ken French; to find out how it performed during the last weeks of bull markets, I relied on the bull/bear market calendar maintained by Ned Davis Research.
Since 1926, this portfolio produced an annualized return of 74.0% in the last three months of bull markets. That’s nearly double the 38.7% annualized return during all but the last three months of bull markets, and a 24.2% annualized loss during bear markets. (These returns are before transaction costs.)
Accordingly, momentum’s recent struggles suggest that a major market top is not imminent. You instead would want to worry when the recent past’s highest-flying stocks are not just continuing to rise, but soaring. So for the moment, at least, momentum strategies’ struggles are not a reason to worry. If anything, they might be keeping the bull market alive.
Mark Hulbert is a regular contributor to MarketWatch. His Hulbert Ratings tracks investment newsletters that pay a flat fee to be audited. He can be reached at firstname.lastname@example.org