When Momo Loses Its Mojo—-Look Out Below!

There are really only two methods of investing that work – momentum and value. Every other method of investing you read about is some variation on one of those themes. Even passive strategies are essentially nothing more than a combination of the two as long as one uses a fairly long rebalancing period (at least a year). That allows your winners to run a bit while the rebalancing is the value part of the equation as it forces one to sell the winners and buy the losers. Markets and their constituents are generally classified as one or the other, value or momentum (growth is just another way of saying momentum).

Over the years since the crisis, US stocks have moved from a value market to an extreme momentum market. It wasn’t momentum guys who were buying in 2009 and it isn’t value guys who are buying today. I think that the indexing of the market through the ETF mania is partially responsible for the extreme momentum exhibited by today’s market. Individual stocks don’t get much attention today; sectors are bought and sold en masse via ETFs and valuation is, at best, a secondary consideration. And for many investors today, investing in US stocks requires no thought at all; just buy the SPY. It’s been going up and what else do you need to know? Expensive isn’t part of the calculus; greed is front and center for anyone who takes the time to notice.

So, if we are in a momentum market it is critical that one monitor momentum indicators. You don’t need to do any complicated valuation calculations because US stocks, as a whole, are not cheap by any measure. There are plenty of ways to confirm that but what I do is run stock screens using value criteria – price to sales, price to book, etc. – and see how many stocks fall out of the screen. Back in 2009 running screens using my value criteria yielded thousands of stocks to choose from. For value investors it was a veritable smorgasbord. Now, when I run those same screens, I get tens of stocks (in the US; there is much more to choose from outside the US) to choose from and most of them appear to me to be value traps, companies with problems over which they have no control.

So, if this is a momentum market, I think it fairly ominous that some of the most momo sectors of the market are now acting a bit tired. A lot of them took hits in the first quarter, recovered through the middle of the year and are now once again rolling over. Energy is the most obvious but far from the only sector getting hit. The first post here at Sigmund Holmes, Boondoggle on the Bayou,  back on June 2, was a warning about the shale industry. In that post I highlighted a stock being recommended by Jeff Saut called Goodrich Petroleum, a highly leveraged shale oil play. Goodrich (GDP), like a lot of the shale plays, was exhibiting classic momentum; it wasn’t trading on fundamentals because frankly there weren’t any. At the time, GDP was trading around 30 and now changes hands in the 4s which is why I don’t play the momentum game; when you are wrong, when the momentum shifts, the losses can be quite dramatic.

There are plenty of other sectors and high flying stocks that are exhibiting signs of momentum exhaustion. The social media space is littered with failing charts from Yelp to Twitter to even Google. Netflix and Amazon look broken, Tesla is coming back to reality. The one area of high momentum that hasn’t broken down yet is biotech. I’d suggest keeping a close eye on that sector as a tell for the entire market. As for the S&P 500, the long term momentum indicators I follow are still positive but waning. Those indicators have been consistently on buy since mid to late 2009 so a sell signal would be significant. Here’s a chart:

spx monthly


The momentum indicators are in the bottom panes and as you can see the last sell signal came in late 2007. They aren’t quite there yet, but if – when – it comes, it should not be ignored.

BTW, since I’m not an expert on this stuff – as I’ve said, I’m a value guy – my friend Mike Oliver, who does nothing but technical analysis on momentum, says the long term momentum structure has already broken down. He is waiting for one last confirmation at the end of the year but he is pretty well convinced that momentum has shifted already. Considering his track record over the years (he called the tops in 2000 and 2007 as well as the bond rally and oil drop this year and a lot of other big moves besides), it’s a warning well worth heeding. Mike runs Momentum Structural Analysis and I’d recommend giving him a call and getting trial set up (I’m not being compensated for that little plug by the way; I just have a great deal of respect for his work).

One last note and what triggered this post. China’s third largest social media company came public today. It’s ticker? MOMO. Sign of a top? I report, you decide.