Tuesday, Sep 10th 2019

The Recent Momentum Selloff


We've seen a significant selloff in Titan stocks recently, driven by a momentum reversal. Here's why, and our take on the path forward.

Over the past few days, we've seen a significant selloff in several Titan stocks. Companies like Twilio, ServiceNow, Visa, and Mastercard have all fallen 5-10%+ from last week's prices.

What gives?

The Selloff Appears to be Momentum-Based##

We've seen large algorithmic institutional investors (e.g., quant funds) rotating out of "momentum"-driven stocks and into traditional "value" stocks.

  • Momentum stocks are stocks that have shown strong recent price strength
  • Value stocks are stocks that screen cheaply based on quantitative historical metrics like price/earnings ratios

Believe it or not, many quantitative hedge funds invest solely on the basis of certain style factors and signals, without any regard to what the underlying company actually does.

Widgets? Software? Restaurants? Who cares, they say. Let's just look at the stock price.

If the stock price for a company continues to rise day after day, a momentum fund's algorithms pick up that signal as momentum and buy the stock themselves, expecting the price to continue to rise. It's the classic "Greater Fool's Theory," if you're familiar with that idea.

As long as the music keeps playing for momentum stocks, funds that invest with momentum-driven strategies can do extremely well. For much of this year thus far, momentum stocks have performed fantastically well, leaving many momentum funds up 50%+ (more than 3x than return of the S&P 500).

But when the music stops (as it always does), momentum comes to a halt and sharply reverses, inflicting a great deal of short-term pain on momentum stocks and the investors who happen to be invested in stocks with a momentum-driven tilt to their recent stock returns.

Is Titan Driven by Momentum?##

We believe momentum has been the primary driver of weakness in Titan stocks over the past few days. However, we do not invest your capital based on momentum trends.

Given that many high-quality, fast-growing companies inevitably catch the attention of institutional investors who invest based on momentum, even the best investors often cannot avoid their stocks being susceptible to momentum reversals.

For example, take a look at some of this year's best-performing Titan stocks. Microsoft (MSFT), Visa (V), Mastercard (MA), and PayPal (PYPL) are some of the most well-known companies around. They dominate tons of ETFs and mutual funds, many of which would not describe themselves as being momentum-based.

And yet momentum is precisely the factor that all of those stocks had in common for most of this year. It's also the factor that's driven their price weakness recently.

Our strategy is based on the highest-conviction holdings of hedge funds that we believe are investing based on fundamentals, not short-term momentum. Over time, momentum's impact wears off vs. the fundamentals.

What's the Path Forward?##

Momentum is a funny thing. It's quite recursive in nature: it gets started when a stock's price increases consistently for an extended period of time, and it stops when, well, the price stops going up consistently.

This recursive nature makes momentum incredibly hard to predict in the short term. Furthermore, momentum is far less relevant to long-term stockholders than short-term traders. So we try to diagnose when it may be driving Titan stocks, but we don't react to it or change course when momentum does.

We believe our best path forward is sticking to our strategy and adding to our Titan accounts via auto-deposits. These momentum reversals are painful in the short term, but buying low and selling high isn't supposed to be easy. This is the behavioral edge we have over the machines.

When People Call the "Top"...##

You may hear friends or colleagues running for the hills and using this momentum reversal in widely-own tech stocks as justification for a "market top."

Don't let the tail wag the dog. Business fundamentals do not care about momentum reversals. When prices fall for technical reasons but fundamentals remain unchanged -- well, you just got the same business offered at a discount.

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