Momentum Correction — Managing Factors

Disclaimer: This is not investment advice.

Momentum stocks have corrected nearly 12% from the highs in February 16th this year. This factor is roughly flat YTD. The sudden correction caught me by surprise — and my portfolio was fairly concentrated in positive momentum stocks (SE, BILI, PPD, etc.).

Was there a way to prevent this?

Summary? Select factors based macro environment. Stay or only buy into supportive trends. Use episodic (not trending) volatility to transact at high / low ends of liquidity.

There are three ways I believe can work to manage these factor swings.

• Factor awareness. Per HedgeEye research, momentum has historically outperformed in improving positive growth and positive inflation environments (i.e. “quad II”). The issue was my concentration in my portfolio which was likely mirrored by many other investors.
• Trend awareness. Two of the largest components of MTUM, TSLA and AAPL started break trend (lower highs and lower lows) February 16th onwards. This could be seen in the decline in the percentage change of prices (daily, five-day, monthly, and YTD).

• Volatility awareness. The final clue is the expansion of volatility which means the liquidity range of the stock is expanding and the downside of the price is larger. The Nasdaq volatility continued upwards from February 10th. I thought it was episodic as it dipped below 30 briefly in March 1st. However, the high IV percentile in stocks like TSLA and PLUG plus signs of trend break-down, suggests a change in trend (i.e. a correction).

Liquid markets move more like the rivers and turbulent winds as described by Mandelbroit than on narrative-type reasons, though the latter is certainly helpful to communicate with.

The very obvious catalyst was the very fast move in 10-year treasury rates from 1.05% to 1.56% from February 10th to March 9th where you can see volatility also expanded very much.

This volatility “wave” was concentrated in momentum and treasury markets. Volatility barely moved in other markets (corporate bonds, equities — VIX)!

Takeaways? Select factors based macro environment. Stay or only buy into supportive trends. Use episodic (not trending) volatility to transact at high / low ends of liquidity.

This is also the HedgeEye process which I am starting to understand more!