Momentum stocks like Netflix, Inc. (NASDAQ:NFLX), Facebook Inc (NASDAQ:FB) and Tesla Motors Inc (NASDAQ:TSLA) have been taking a beating since last month, but will those stocks drag key indexes down? Goldman Sachs analysts believe the S&P 500 will recover over the next few months but that momentum stocks probably won’t.
Momentum stocks plunge
In a report dated April 11, 2014, analyst David Kostin and the rest of his team at Goldman Sachs note that over the last month, momentum across the markets has fallen by 7%. That’s the “10th percentile ranking of all monthly momentum returns since 1980,” according to their records. They “define ‘momentum’ as the relative performance of the best vs. worst performing S&P 500 stocks during the prior 12 months. Specifically, they noted 46 different 10th percentile declines, which posted on average, -8% returns and a cumulative -10% return over six months.
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Lessons about momentum reversals
The Goldman Sachs team said from looking back through history, the S&P 500 could recover over the next few months. They note that the index saw an average 5% six-month return after each of the 46 drawdowns and posted positive returns 70% of the time. Meanwhile momentum stocks fell by an average of 4% further and posted negative returns 60% of the time.
They say history tells us that probably about 70% of the momentum reversal is over after last month’s 7% unwind. In addition, they suggest that there’s an extra 3% downside in the reversal over the next three months if this reversal follows the past average reversals. In addition, there could be an extra 7% downside to momentum stocks if this year’s pattern follows the “path of a 25th percentile event.” And whenever the
Why the S&P 500 might recover
The analysts say the performance of the broader markets will likely rise steadily over the next six months, increasing by an average of 5%. That increase would raise the index to a little over 1900, which is where Goldman Sachs’ year-end projection falls. If this year proves to be closer to a 25th percentile trajectory, the equity market could be flat over the same trajectory. On the other hand, a 75th percentile track would mean the S&P 500 would increase by 15% to around 2090 by the end of the third calendar quarter of this year.
The Goldman Sachs analysts say trends suggest that within the S&P 500, low valuation and low growth stocks could outperform in the wake of this momentum reversal. They have put together a list of stocks with qualities that have tended to outperform after momentum stocks reverse. The stocks are among the 100 worst performers over the last 12 months.
Potential winners and losers
As you can see, International Game Technology (NYSE:IGT) is at the top of the list. Other stocks of note that are included are Avon Products, Inc. (NYSE:AVP), Wal-Mart Stores, Inc. (NYSE:WMT), and Family Dollar Stores, Inc. (NYSE:FDO). Several of the stocks on Goldman’s list are edging upward this morning.
On the other hand, most momentum stocks could continue to decline over the next few months. Forest Laboratories, Inc. (NYSE:FRX) tops the list. Other big names on the list are Facebook Inc (NASDAQ:FB), First Solar, Inc. (NASDAQ:FSLR), Yahoo! Inc. (NASDAQ:YHOO) and Chipotle Mexican Grill, Inc. (NYSE:CMG).
Comparing momentum stocks today with 2000
The Goldman Sachs Team says many clients have been questioning whether this time around will turn out to be anything like the reversal of 2000. They note that it does share some similarities, including concentration in technology stocks. Both the S&P 500 and the NASDAQ peaked in March 2000. The S&P 500 declined by 50%, while the NASDAQ fell 75%. The latter recovered after seven years, although the NASDAQ is still 25% lower than its peak.
Why this time looks different than 2000
The analysts note several differences between today’s reversal and the one that happened in 2000. They say the 12-month returns are similar, but the trailing 3-year and 5-year returns are far lower. In addition, they say the valuation isn’t as stretched and say the markets are more balanced now than they were then.
They also say expectations for earnings growth are less aggressive now and interest rates are “dramatically lower” They also see fewer initial public offerings this time around.