The Share of Momentum Stocks in the S&P 500 Reaches Its Highest Level in History, but That Doesn't Mean a Bubble Has Formed.

Over the past year, momentum stocks have exerted significant influence on the market, leading to their weight in the S&P 500 reaching unprecedented levels, as detailed in a report by Piper Sandler market strategists. This trend isn't surprising considering the S&P 500 momentum factor has surged by 20% since the start of 2024 and by nearly 50% over the preceding 12 months, as observed through the performance of the Invesco S&P 500 Momentum ETF (SPMO). In contrast, the Invesco S&P 500 low-volatility ETF (SPLV) has only seen a modest 6.4% increase over the past year.

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Historically, periods of such pronounced outperformance have often coincided with stock-market bubbles. However, Piper Sandler analysts note several key distinctions between today's momentum stocks and those that characterized the dot-com crash in 2000.

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Unlike the late 1990s and early 2000s, contemporary momentum stocks are synonymous with high-quality companies. This implies that their significant surge over the past year is supported by fundamental strengths rather than mere speculative enthusiasm.

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Notably, recent data indicates a close alignment between the momentum factor and stocks demonstrating high return on equity, with nearly 100% correlation over a 36-month rolling period. This contrasts starkly with the early 2000s, when momentum trades were more heavily associated with consistently loss-making firms, displaying over 50% correlation with the negative earnings factor.

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Moreover, current momentum stocks are not as overvalued relative to the broader market as they were in 1999 before the dot-com bubble burst. While high-momentum stocks previously traded at over two times the valuation of the broader market, today, this ratio stands at approximately 1.3, suggesting a more tempered valuation.

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Furthermore, while there has been considerable attention on the top 10 stocks in the S&P 500 accounting for over 30% of the index's weight, the outperformance of these largest stocks hasn't reached the extremes witnessed during the dot-com bubble peak.

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A momentum stock is typically defined as a stock that has experienced substantial price appreciation over the past year. The premise behind this factor is that momentum tends to persist, with stocks that have performed well in the recent past likely to continue doing so in the short term, according to a report by MSCI.

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Although momentum stocks have historically outperformed benchmarks across various countries and sectors, they have also been prone to crashes. Stocks included in MSCI's momentum benchmark must demonstrate a risk-adjusted return that surpasses their benchmark over the preceding six to 12 months.

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Despite their historical outperformance, momentum stocks were lagging behind the broader market on Thursday, with the Invesco momentum ETF experiencing a 0.7% decline to $78 per share, compared to a 0.3% drop in the S&P 500 to 5,152 as of midday in New York. Notably, more than half of the momentum ETF's decline was attributed to Nvidia Corp., which was down over 3% at $878 per share.

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Additionally, shares of JPMorgan Chase & Co. and General Electric Co. were also significant contributors to the ETF's decline on Thursday, according to data.

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