Recent weeks have seen a shift in the equity momentum that fueled one of the strongest starts to the year since 1995, with broad gains across various regions, excluding China.
This change follows a dovish turn at the end of last year. Since then, the US momentum factor has achieved a three-month Sharpe ratio close to 8 times, almost doubling the risk-adjusted returns of the S&P 500, Goldman Sachs strategists observed.
Despite these impressive gains, the high level of market concentration has led to growing concerns among investors about the potential for a market reversal and a subsequent drop in equity values.
“But as our US strategists have shown, periods of high market concentration and momentum outperformance have generally been followed by 'catch-up' rather than 'catch-down' episodes, supported by better macro,” analysts said.
Year-to-date, the US momentum factor has excelled, propelled by momentum in reflationary growth. Initially, the success of equity momentum was primarily attributed to quality and growth sectors. However, cyclicals have recently emerged as the more significant driving force behind this performance.
“While equity momentum has somewhat supported broader risk appetite, we see limited implications of a continued reversal barring a material US rate shock,” analysts commented.
“A hawkish surprise from this week's BoJ or FOMC meeting could weigh on momentum and on risk appetite,” they added.
Equity momentum has played a role in bolstering overall risk appetite, but the potential for continued reversal seems limited unless there's a significant shock in US interest rates, analysts noted.
Unexpectedly hawkish outcomes from this week's Bank of Japan or Federal Reserve meetings could negatively impact momentum and risk sentiment.
Under these circumstances, Europe’s GRANOLAS stocks are expected to be in a more defensive position compared to the 'Magnificent 7'. Goldman has been overweight in equities but there is “limited upside to our strategists' price targets near-term,” analysts observed.
“In case of a setback, e.g. due to a rate shock, we would 'buy the dip' in our macro baseline of good growth and further inflation normalisation,” they said.