A long-successful strategy of chasing stock market momentum has abruptly lost its effectiveness in recent trading sessions. Momentum trading, an investment approach that involves buying rising assets and selling falling ones, experienced its second-largest single-day decline since the 2020 pandemic on Wednesday. This drop surpassed selloffs triggered by last year's DeepSeek event and April's tariff tensions.
According to Goldman Sachs' high-beta momentum stock portfolio data, the decline erased all gains achieved this year by companies in sectors including memory chips, metals and rare earth mining, and technology application development. The collapse of momentum strategy forms part of a broader selloff affecting U.S. stocks this year, with direct triggers including sharp volatility in the software sector. Market concerns about potential substitution effects from artificial intelligence applications on certain businesses caused the sector to drop over 20%.
Despite the selloff, several sectors demonstrated resilience, providing comfort to investors maintaining bullish outlooks. Market observers noted sustained price increases for clothing retailers, travel companies, and home goods manufacturers, alongside significant capital inflows into previously underperforming value stocks. A broad style rotation is emerging as funds move away from technology sectors toward areas with stronger correlation to economic recovery.
UBS's value stock long-short strategy basket has gained 20% since last week, while Barclays' value versus growth factor index recorded one of its largest historical single-day excess returns on Thursday. Christopher Cain, U.S. quantitative equity strategist, commented: "After years of growth leadership by large technology stocks, market leadership is expanding from crowded momentum plays to previously neglected areas like value stocks and small caps. This represents a healthy market evolution."
However, technology sector declines and their substantial index weighting haven't been offset by gains from this style rotation. The S&P 500 fell 1.2% on Thursday, marking its third consecutive daily decline, with year-to-date losses reaching 0.7%. Technology stocks have become nearly synonymous with momentum trading, particularly software companies that have declined for over a week.
Recent earnings reports from major technology firms further heightened market caution. While Alphabet achieved robust revenue growth, it disclosed that 2026 capital expenditures would significantly exceed market expectations. Qualcomm issued weak revenue guidance, and Arm's sales forecast, though exceeding most institutional predictions, failed to meet the market's most optimistic valuation levels.
From a positioning perspective, this selloff follows historically elevated levels in momentum trading. Goldman Sachs trading department data indicates current market exposure to momentum stocks sits at the 99th percentile over the past year and the 100th percentile over five years. Momentum factor volatility also registers at extreme highs compared to historical levels.
Despite the downturn, Goldman's trading team noted potential comfort for investors considering positioning during the pullback. The team wrote in a report: "Historical experience suggests momentum stock corrections represent favorable medium-term buying opportunities." They simultaneously cautioned that given the factor's substantial prior gains and current high positioning levels, short-term hedging remains a reasonable consideration.
Comments