Momentum-driven trades quickly reverse as a worldwide market downturn sets in

Momentum Stocks Face Major Setback Amid Market Turmoil

Momentum investing, once a favorite strategy on Wall Street, has recently suffered one of its sharpest declines in years due to a combination of negative factors. This approach, which focuses on buying top-performing stocks and selling laggards, had outperformed other investment styles over the past year. However, last week it fell to the bottom of the pack as escalating tensions between the US and Iran, disappointing employment data, and concerns about artificial intelligence rattled investors. Early Monday, a global momentum stock ETF dropped over 2%, signaling a deepening shift away from previously high-flying shares.

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The popularity of momentum trades reached unprecedented levels, with Goldman Sachs reporting that hedge funds’ net exposure to this strategy was at a multi-year high, nearing historical extremes.

Lee Coppersmith, a managing director at Goldman Sachs, noted, “The market remains heavily invested in the stocks that have led this cycle. While this concentration isn’t usually a problem during rallies, it becomes a risk if those leaders start to falter.”

The recent downturn in momentum stocks has occurred alongside a broader market selloff, pushing major US indices into negative territory for the year. Futures suggest further declines as oil prices surged above $100 per barrel. The brunt of the selloff has been felt in software companies, where rapid advancements in AI have sparked fears of disruption, causing some stocks to plunge by double digits.

Some market analysts believe the selloff may be nearing exhaustion. According to Barclays, the momentum factor experienced its third-largest single-day drop in two years last Wednesday, a move that has previously marked short-term bottoms before recoveries.

Alexander Altmann, who leads global equities tactical strategies at Barclays, described the situation as a “full-blown panic unwind,” with extreme stress evident across global stocks. While further downside is possible, his team believes the worst may be over, as Wednesday’s move was among the most severe in recent years.

Market Volatility Intensifies

The conflict involving Iran has added to market instability, raising fears of an energy supply shock on top of existing worries about AI. The situation worsened on Friday when the latest US jobs report revealed unexpected job losses and a higher unemployment rate, casting doubt on the labor market’s resilience as inflation risks from rising oil prices persist.

Michael Toomey from Jefferies observed that the sharp swings in equities have caused significant pain for investors, especially those holding former market leaders. Last week’s three-day decline was the fourth-worst stretch in nearly three years, according to his analysis.

Toomey is monitoring several contrarian signals that could indicate a rebound is near. For example, crude oil has entered overbought territory, and the Cboe VIX Index curve has fully inverted, reaching its highest point since last April’s tariff shock—levels that have historically preceded buying opportunities in stocks.

Story updated with the latest market developments and expert commentary.

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