Value ETFs Could Thwart Momentum In Second Half

The momentum factor and the corresponding exchange-traded funds have been thumping value stocks and ETFs to start 2017. Sure it is just one comparison, but one week into July, the iShares Edge MSCI USA Momentum Factor ETF MTUM is higher by 18.7 percent year to date while the iShares Edge MSCI USA Value Factor ETF VLUE is up just 5 percent.

Momentum ETFs have been, in large part, bolstered by sectors that some market observers view as richly valued. That includes technology and consumer discretionary, which are usually the two largest sector weights in most momentum ETFs. Conversely, value ETFs are often heavily allocated to energy, the worst-performing group in the S&P 500, and lagging financial services stocks.

A case can be made that value will have its day in the second half of this year, particularly if energy stocks rally and/or the FAANG stocks continue retreating.

A Perfect Storm

For the bulk of the first half of the year, momentum stocks had the wind at their backs. In some ways, the environment for momentum, including the FAANG quintet was almost too good to be true.

“Historically, momentum performs best in an environment of low and stable volatility — exactly the regime that has dominated this year. Although talk of reflation faded, low interest rates, a soft dollar and historically tight spreads kept financial conditions absurdly easy,” said BlackRock in a recent note. “In June, the Global Financial Stress Index hit its lowest level since late 2014. A lack of stress and easy money tend to support momentum investing. In this environment it is best to follow Newton’s First Law of Motion: An object in motion stays in motion.”

It was also a perfect storm in which value stocks could lag. Oil prices are essentially in a bear market and financial services, the one sector that is undervalued relative to long-term averages, was not all that responsive to first-half rate hikes by the Federal Reserve. VLUE allocates 20.6 percent of its combined weight to those sectors.

Cracks Are Appearing

There is some evidence suggesting the momentum trade is losing, well, momentum.

“History may be repeating itself as we’re starting to see the first, albeit small, cracks in the momentum trade,” said BlackRock. “While still posting stellar year-to-date returns, momentum was down around 1% in June, underperforming both quality and value. Should financial conditions continue to shift, volatility is unlikely to remain as quiescent.”

Even a modest second-half uptick in volatility could send investors to more the more stable pastures of the value factor and ETFs like VLUE.

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