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Inside Markets — Momentum Factor

Momentum Factor

February 21, 2024

The momentum factor is unwinding at the moment with hedge fund and retail investor positioning metrics at/near record levels. The duration and magnitude of the move will be heavily influenced by NVDA’s earnings report this afternoon.  Using the ‘Magnificent Seven’ as a proxy for the momentum factor, this crowding is not without fundamental justification.  In FY’23, the Magnificent Seven recorded a +14% YoY increase in revenue vs. +2% for the remaining 493 companies in the S&P 500 (SPX).  Bottoms-up consensus estimates for sales also see the group at a +12% CAGR through 2026 vs. +3% for the SPX 493. In FY’23, Magnificent Seven profit margins expanded +750bp vs. -110bp for the SPX 493.  And bottoms-up consensus estimates are looking for 256bps of margin expansion for the Mag 7 over the next 3 years vs. +44bps for the SPX 493.

Bull markets characterized by narrow leadership are unsustainable.  Last week’s strength in the Russell 2000 (RTY) and equal-weight S&P 500 (SPW) gave us some hope for improved market breadth.  We are most interested in the RTY because it’s a cyclical proxy.  Last week, the RTY rejected the 2000-2100 resistance level for a fourth straight time in the last ~18 months.  While it’s not our expectation, sustained closing levels above ~2070 would be a bullish sign for the RTY and the broader market.  The forward multiple on the RTY is trading at a rare discount to the SPX and its relative underperformance has reached an all-time record.  A period of mean reversion is likely to generate significant alpha, but it seems unlikely in the current environment given extremely restrictive real yields.

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