Fascinating new data from Bank of America shows how terrified money managers are chasing the stocks that have already gone up, in the hope of not getting fired for missing the latest rally.
“Active investors are now “buying what’s working” more aggressively than usual,” write the bank’s quantitative data team in a new report. So-called momentum stocks, meaning the stocks that have already risen the most in the past 12 months, are now heavily overbought and overvalued as a result, they say.
“Our 12-month price momentum factor is almost 25% more overvalued on forward earnings than usual, and this basket of stocks with the strongest returns over the last 12 months are, in aggregate, overweight by … institutional long-only investors relative to the benchmark.”
It’s a fascinating insight into what’s driving the market now. FOMO, or Fear of Missing Out. Money managers don’t want to risk their careers by missing out on the rally. They have their yachts to worry about. The customers’ yachts, famously, are a secondary concern.
Seems like only a couple of months since the market was plunging in terror about a trade war that was going to ruin us all.
(Oh wait… it was only a couple of months ago. But the market couldn’t be irrational, could it?)
The number-crunchers at Bank of America note that panicked, herd-like money managers aren’t just covering their rears by buying “what’s working.” They’re also avoiding stocks that seem to offer the lowest earnings risks.
“Companies with a high level of “analyst disagreement”,” meaning those where the analysts’ earnings forecasts vary the most, are now “deeply underweighted by active funds,” they write. Stocks with the most earnings uncertainty are now trading at deep discounts in terms of price-to-earnings ratios.
Oh, and FOMO is also panicking hedge-fund managers, even though they’re supposed to be zigging when the rest of the market zags.
“A fear of being different is also evidenced in an increasing overlap in holdings of hedge-fund and long-only managers — in fact, the overlap between long-only and long-short funds’ top 50 stocks is close to record highs,” they say.
Hedge funds are also net long of “high momentum” stocks, they add. That’s just peachy. They’re charging clients hefty fees for “hedging,” and then they’re not hedging. We’ve seen this movie.
Buying stocks with “momentum” is one of the most successful strategies on Wall Street. It’s also one of the most dangerous, because when momentum reverses it can do so hard.
A strategy that bet on the 20% of stocks with the most momentum, and bet against the 20% with the least momentum, would have lost 70% of its value in 12 months just after the financial crisis, James White and Victor Haghani at money management firm Elm Partners recently pointed out.
Bank of America notes that so-called “value” stocks, “high-quality cyclicals,” and companies with a lot of earnings uncertainty are all being left behind by the charging market. They may offer great long-term opportunities.
No one knows when this will turn. Momentum can keep going for a very long time. But chasing it too hard can be a dangerous game.