Momentum continues to face headwinds, but historical drawdown patterns suggest the most severe phase may have passed. Outside of recession periods, max price mo drawdowns following a 20% decline have averaged around -25%. Hedging of residual downside risk remains warranted, and we highlight Value as a structurally compelling approach given it’s negative correlation to Price Momentum.
The name overlap between the top-decile Momentum and Value has declined to the low end of its historical range, supporting the negative return correlation between the factors. This dynamic was visible last week, when both Price Momentum and Realized Value outperformed in a range bound market. Currently, high Value industries, Energy, Financials, and Retail are exhibiting negative Momentum exposure, while high Momentum industries such as Semis and Tech Hardware are negatively exposed to Value. Again, this helps explain the persistent negative correlation between the two factors and the basis for hedging Momentum downward pressure.
Beyond pure Value as a hedge, stocks with strong dual exposure to both Value and Momentum have historically outperformed both factors separately and have shown notably lower volatility during the current drawdown. Under the prevailing Normal macro regime, Value has delivered consistent positive monthly returns, making it a well-suited complement to Momentum-oriented portfolios amid lingering macro uncertainty. The S&P 1500 names with both high Value and Momentum exposure are listed at the end of the report.
Value as a Hedge to Momentum Risk: Momentum factor continues to see downward pressure, though the worst scenario may be behind us. Historical max drawdowns for Price Mo after dropping -20%, outside recessions, was around -25%, suggesting limited further downside from current levels. That said, hedging residual tail risk in Momentum remains prudent. We discussed a dynamic adjustment strategy for Momentum risk (HERE), and 22V’s Derivatives expert Jeff Jacobson also proposed several option hedges (HERE). In addition, we see Value names as a hedge to current Momentum risk given the negative correlations between the factors.
The overlap between top decile Momentum and Value names has dropped to the low end of its typical range. As a result, factor returns between Value and Momentum are negatively correlated now (2.3nd %tile). Momentum headwinds should be a support to Value names.
Last week, both Momentum of Price and Realized Value outperformance broadly across all sector groups of S&P 1500, which is a result of range bound market with negative return correlation between the two factors.
It is hard to predict the unwinding of the current Momentum headwinds, while stocks with both strong Value and Momentum exposure tend to perform better than Momentum and Value baskets longer term. Importantly, the basket shows clear lower volatility under the recent Momentum pull back and can be an addition to hedging further Momentum drawdown risk without sacrificing upwside potential.
Currently, the industry groups with high Value exposure are Energy, Financials, and Retail, which we still favor as duration sensitive groups under a 4.2-2.5% 10yr yield range (HERE). The industry groups most exposed to Value also have negative exposure to Price Momentum, while the most Momentum driven industries such as Semis and Tech Hardware are less Value exposed. That explains their negative correlation and why adding Value exposure helps hedging Momentum risk.
Under the current Normal macro regime backdrop, Value factors have consistently shown positive monthly returns. As the path for inflation and financial conditions remain uncertain, fundamental factors are positioning better than Risk factors under current backdrop.
Below we list S&P 1500 names with both strong Value and Momentum exposure. We can screen for pure Value names as an addition to Momentum portfolios as well.
