Momentum Trade Struggles in Second Half of Year

Momentum shares drove the market gains early in the year, and it will be harder for the rally to continue without their participation. Momentum is one of the factors that mathematically minded investors use to describe and organize the market according to certain well-understood market trends. Momentum stocks are defined as shares that have been going up and outperforming the broader market for roughly a year. A broadly followed ETF built on stocks that qualify as momentum trades is up roughly 33% over the last 12 months, handily outperforming the S&P 500's 20% gain.

The momentum trade has been one of the best-performing market trends of the last year, with chip and memory stocks being some of the biggest contributors to its outperformance. However, since July, momentum is one of the worst-performing factors. The biggest clue to this selloff can be found in the timing of the momentum selloff, which began shortly after the Federal Reserve's latest interest rate decision. Interest rates rose in the days after the June 18 decision to hold rates steady, and the market seemed to view the Fed under new chairman Kevin Warsh as more likely to raise interest rates or less likely to cut them than previously expected.

The iShares MTUM fund, which tracks momentum stocks, was down a bit more than 11% through its worst moments on Tuesday, which roughly meets the standard of a correction. The ETF is now down roughly 8% for the month, which would be its worst monthly showing since early 2022, when the Fed was also sending signals that it was about to ratchet up rates to beat back the post-COVID inflation.