Momentum Stocks Are Broken. How Do We Profit From It?

Momentum is a word that gets thrown around a lot. I personally like to measure momentum using a 14-period relative strength index (see here), but different people have different definitions. Fine. For today, we’ll argue that “momentum” stocks are those listed in the MSCI USA Momentum Index. Looking at these stocks as a group, I think they are going to continue to get destroyed going forward, particularly relative to the rest of the market.

First of all, forget this whole FANG thing. I don’t know who made that up or why people like to limit it to just 4 stocks. I think it’s stupid. They have nothing to do with one another and there should be others included in the list. In fact, in November I wrote a piece about how FANG stocks are this cycles Four Horseman (See here) and was further evidence at the time that made us very bearish U.S. Stocks heading into December and January. That obviously worked out very well.

Secondly, the list of “Momentum” stocks, includes more than just these 4 FANG names, hence my use of the adjective stupid. You can get more information here from iShares, but half the index basically consists of technology and consumer discretionary names: Google, Amazon, Facebook, Home Depot, Visa, Starbucks, McDonalds, etc. It’s a list of large and mid-cap stocks with relatively higher momentum characteristics. The way I see it, the last men standing in a bear market for U.S. Stocks.

Anyway, I think the main point I’m trying to make here is that these “momentum” stocks are done for, especially relative to the S&P500. Remember what happened to the Four Horseman in 2008? They all got destroyed. I would expect the destruction in this cycles’ version: FANG, as well as the rest of the momentum stocks to continue well into 2016.

Here is a chart of the iShares MSCI USA Momentum Index ETF $MTUM vs the S&P500. In other words, Momentum stocks compared with the rest of the market:

Notice how we briefly put in a new highs last month before quickly reversing. This confirmed a failed breakout as well as a bearish momentum divergence. This is a beautiful recipe for disaster and we fully expect this group of names to continue to get crushed.

This destruction can also be seen in the individual components. Amazon put in a beautiful failed breakout in late December, Google put in a beautiful failed breakout after its most recent earnings release. It certainly appears that Facebook is doing the same thing. There is an ongoing theme here that I love to see: Momentum stocks failing and breaking down. I believe this trend is here to stay and we want to be shorting momentum stocks very aggressively, particularly relative to the S&P500. I think for every dollar short $MTUM we can be long one dollar of $SPY.

There is a pretty clean uptrend line (not shown here) from the 2014 lows in this spread. I think the failed breakout over the past week in this ratio will be the catalyst to send prices tumbling and below this uptrend line. I would get the heck out of the way in this one or short it outright as long as we are below the September highs. The risk levels are very well-defined and I would not be covering any time soon. Rather, I would prefer to sell into any strength, if we get it.

I think this is a great trend. I like it.