Most investors recognize two main categories of stocks, growth stocks and value stocks. But a third category, momentum stocks, have caught fire in recent years – both in popularity and performance. Momentum stocks are the stocks that have recently done the best. That is, buy the winners hoping the outperformance will continue. This strategy has worked in large part during this bull market but sharply reversed last week. Low-momentum stocks outperformed high-momentum stocks by the most since 2009, while value stocks outperformed growth stocks by the widest margin since 2001!
Why the sudden shift? Before last week, investors appeared to be betting that bond yields would fall due to a slowing economy on the brink of recession. But last week rates rose sharply. Quickly the future looked less dark, so investors sold their defensive positions (many were high-momentum stocks) and bought depressed value stocks that will benefit if a better economic outlook lifts everything – mainly financials, industrials, and energy stocks.
Timing value-growth cycles can be as impossible as market timing – even though growth stocks have outperformed handily in this bull market. That’s not always the case. Value stocks will again have their day. Was last week the beginning of a style shift? Too early to tell. The best thing investors can do is to stay diversified – have both growth and value stocks in a portfolio – especially if they are retirement assets. Having both styles reduces volatility and ensures you own today’s winning style – and realizing it can change tomorrow.
High-momentum stocks, however, are a different story and can be dangerous to buy in conservative portfolios – mainly because many of them are detached from any rational valuation. To buy a stock just because it has outperformed is silly in our view. High-momentum stocks take the escalator up and the elevator down. Chasing road runners can be hazardous to a portfolio’s health.
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As expected, the Fed cut the Fed funds rate yesterday by ¼%, the second rate reduction this year. Fed Chairman Powell gave a positive assessment of the domestic economy but lowered rates anyway due to global economic slowing and trade concerns. He also reiterated that the move is an insurance-style cut and not the beginning of a pathway to zero interest rate polity (ZIRP). Investors, however, expect at least one more decrease later this year. That would leave little ammunition for the Fed if confronted by a recession.
The need for yesterday’s cut is questionable. Further cuts are not necessary unless the economy takes a quick turn south – very unlikely in our view. Fed Chairman Powell was right not to signal more rate cuts by year-end.