Performing a (semi) annual checkup on markets with momentum

Much in the same way our body requires a checkup, so do markets and our investments. Having up to date information allows us to stay healthy, understanding where we’ve come from and where we want to go. In the same way, we can use a transparent and rules-based approach to take stock of past investment trends and identify current price trends to see which direction markets are going.

I visit the doctor once a year to get an annual checkup. A day or two before, I admit I try to cut out my daily allotment of potato chips and cut down on the soft drinks (there’s always hope!). But the underlying trends in my blood pressure and the markers, lipids, and counts in my blood tests and other vitals don’t lie—they reflect my underlying health. How does one perform a checkup on markets? Twice a year the underlying index for the iShares MSCI USA Momentum Factor Index ETF (XMTM) evaluates the market based on both 6 and 12-month risk-adjusted returns¹ , rebalancing into different style, sector and stock exposures that ultimately answer the question “which trends are healthy in markets?” Because ETFs are transparent, it takes just one click to see XMTM’s holdings², which as of the end of November are freshly tested.

So, what are the results?

Checking up on market momentum

In the semi-annual rebalance in May, we saw market momentum shift from a strong growth orientation to a greater blend of value, core, and growth. This was brought on by the good news of Pfizer announcing their vaccine was effective against covid in November of 2020. This meant the market could rotate from stocks favored by social distancing and lean into those more connected to a physical world.

Since then, the reopening trade has taken a step back for various reasons, including rising COVID cases and the emergence of variants. At this most recent rebalance, we’ve seen market momentum give up some of that value exposure, again favoring core and growth.

Composition of market momentum (XMTM) over the last 5 years

From a sector standpoint, XMTM increased its weight in information technology considerably. At first glance, this is expected given momentum’s rotation back into growth and core. However, by that logic one might think it would increase its weight to communication services and consumer discretionary as well, but market momentum has instead favored health care and energy.

An interesting side note is that XMTM has historically been light on the energy sector, but over both the past 6 and 12 months, the energy sector has been the best performing, overcoming its tendency to be higher volatility. This serves as a healthy reminder that analyzing momentum is ultimately a bottom-up approach, whose resulting sector and style allocations are a result of measuring individual securities, rather than specifying top-down broader sector or style trends.

XMTM underlying index “Pre” and “Post” rebalance GICS sector allocations

Notable changes in the top 10 holdings

Given the bottom-up approach, it can be useful to understand which of the largest securities are moving in and out of momentum. Below we see the top 10 holdings before and after the rebalance, noting that at each rebalance, XMTM’s index sets portfolio weights to a maximum 5%. This encourages diversification and limits potential reversal effects of individual securities. As we can see below, TESLA had its weight reduced from 8.4% to 5.3%, and Microsoft was a new addition to the fund.

“Pre” and “Post” rebalance XMTM’s index top 10 holdings

Momentum: the chameleon factor

Many in the financial community refer to momentum as the chameleon factor and rightfully so. Momentum adapts to markets and provides a lens to view deeper and more robust trends—just like a checkup provides a view into our underlying health. While investors can seek excess returns via momentum funds such as XMTM, momentum can also be used alongside other factors to seek additional diversification. Due to its role as both a potential return enhancer and because it reflects ongoing market trends, conducting a semi-annual checkup on market momentum can provide valuable information no matter your investment strategy.