Momentum stocks see strongest advance since 1999

Slice the rally however you want: chips, Nasdaq, retailers, banks. But 2017 will go down as the year an investment strategy based on nothing more than sticking with winners shined brightest.

Long momentum, when traders simply buy shares that are rising the fastest, returned 38 per cent in 2017, the strongest advance since 1999. Paced by firms like Square Inc. and Align Technology Inc., the strategy came within an inch of surpassing its advance the year before the dot-com crash.

More than a quantitative quirk, the overwhelming success in momentum investing was one of the things that made 2017 a turning point in equities for many observers. Less hated, less distrusted, the bull market born at the bottom of the financial crisis took on more of a speculative mien, with gains massing in fewer shares and valuations pushing ever higher.

“I can give you a million things on why (last) year was abnormal,” said Donald Selkin, New Yorkbased chief market strategist at Newbridge Securities Corp. The firm oversees US$2 billion. “Look at the levels of volatility, look at the FANGs, look at the S&P’s rally. The market has rallied tremendously, but it’s hard to imagine the party will last.”

Much that went on in the market was healthy. Gains in the S&P 500 matched the annualized advance since the bull market began. While price-earnings ratios widened, it happened as earnings themselves were rising at an 11 per cent clip. Away from technology, gains were evenly divided, with returns in five different industries clustered close to 20 per cent.

A simple concept, momentum investing is a tool of sophisticated traders, an equity “risk factor” that is the subject of copious academic research. Heavy lifting in the trade was handled by a familiar set of technology megacaps — Apple Inc., Facebook Inc., Amazon.com Inc., Microsoft Corp. and Alphabet Inc. — which were responsible for about a fourth of the S&P 500’s gain.

Given its role in passive strategies and the amount of money tied in through exchange-traded funds, momentum’s success, particularly in a year of scant volatility, was sure to strike some as having come too easily — a mindless harvesting of returns that rings alarm bells among the prudent. This year’s monotonous climb has left the S&P 500 with a positive total return in 14 straight months, a record.