Market sentiment dramatically shifted in November with the sudden announcement of promising COVID-19 vaccine results and the outcome of US elections. In an effort to get ahead of the changes in company earnings and opportunities that would be expected as life gradually returns to normal, market participants abruptly moved away from stocks that would be expected to thrive amid lockdowns and other restrictions and toward businesses that depend on the resumption of normal life.
We expected market action motivated by increasing certainty about the end of the pandemic to drive up the prices of the stocks that have suffered most during the crisis – but we also realize that this pattern will be limited to a short period. We invest for a longer horizon.
Low-momentum, High-risk Stocks Suddenly in Favor
The shift in market sentiment manifested itself in sharply negative returns for stocks with high price momentum and strong positive returns for stocks with low price momentum – in short, a clear example of price reversal (see Figure 1). It’s very unusual to see a reversal of this magnitude – the last time we saw one of this size was in March 2009 – but it is characteristic of price momentum, which has a pronounced negative skew in its return payoff. (Put another way, price momentum has historically generated frequent and consistent incremental positive returns, but the occasions where returns are negative have been much more severe.)