Summary: The biggest momentum ETF in the US is about to rebalance and based on the current momentum factor scores technology and financial stocks are going to be cut with the biggest effect on the biggest index weight names such as JPMorgan Chase, Tesla, Microsoft, and Bank of America. Momentum strategies are adjusting to the new trend of value stocks suddenly being where momentum is and this rotation could add to the selling pressure in technology stocks. Tesla has also recently been kicked out of the S&P ESG Index and thus multiple funds will likely soon begin reducing Tesla shares.
The biggest rotation on record in momentum funds is coming
According to a recent Wells Fargo research note, the $9.8bn momentum fund iShares MSCI USA Momentum Factor ETF (MTUM) could be on its way to make its biggest rotation on record due to a dramatic shift in the momentum factor away from information technology and financials, and into health care, consumer staples and energy stocks. MTUM is down 28% mimicking the downfall of the Nasdaq 100 underscoring the overlap between the momentum factor and the recent years of technology outperformance, and now the unwinding of that alpha.
Based on the MSCI’s methodology behind the momentum factor we calculated the combined momentum score for the 30 largest positions in the MTUM fund. As the table shows, stocks such as BlackRock (what an irony being the owner of the fund itself), Goldman Sachs, Adobe, Alphabet, Oracle, Moderna, Bank of America, and JPMorgan Chase are some of the big losers. The winners are Eli Lilly, Costco (not for long with carnage in US retailing), ConocoPhillips, EOG Resources, Devon Energy, and Occidental Petroleum. But momentum in Tesla and Microsoft has also faded and will be reduced upon the next rebalancing, and due to the momentum factor methodology those with the highest underlying weight in the index (in this cases the MSCI USA Index) will be hit harder.
This week Tesla was also removed from S&P’s ESG Index due to the company lacking on the S and G driven by questionable working conditions at its factories and investigations related to accidents with its autopilot, according to the S&P statement. Other ESG funds are still holding Tesla, but the tide is shifting and Tesla could experience more selling from ESG funds going forward. Combined with the momentum rotation this could lead to a sizeable selling from multiple funds. Momentum strategies come in many different shapes and across private accounts, advisory accounts, ETFs, mutual funds, hedge funds etc. and thus the combined rotation is a lot bigger than the MTUM would suggest.
The momentum factor explained
The MSCI Momentum Factor methodology is defined in this paper and is basically a combined measure of the 6-month and 12-month price momentum (that is total return over that period), where the last month is removed due to short-term mean-reversion effects in the market (what has risen a lot recently tends to go down the following month). These raw measures of momentum is then standardized using the annualized volatility of the stock using 3 years of weekly observations. This combined momentum score is then further standardized to a Z-score which is then winsorized to 3 or -3 which means that any value above or below 3 or -3 are capped at these thresholds. This avoids dramatic outliers to cause a big weight change which is costly for the fund and very high Z-score values would most likely be noise anyway. These Z-scores are then turned into a momentum score which is multiplied by the underlying weight in the tracking index and then normalized to 100%, so the fund becomes a long-only fund with 100% investment. This means that a dramatic shift in the momentum score for those stocks with a large weight in the underlying will get increased or decreased in an amplified manner.
Source: Saxo Bank