Leading stocks showing signs of fatigue — cause for worry?


Some of Wall Street’s favorite stocks from the technology and healthcare sectors have stumbled recently, which has raised questions about the integrity of the overall market even though the S&P 500 hit fresh record highs this week.

In particular, traders have been keeping an eye on the iShares MSCI USA Momentum Factor ETF (MTUM). The fund holds stocks that have performed strongly in recent months. The idea is that shares that have risen sharply recently will continue to do so.

Top holdings in the momentum ETF include search leader Google (GOOG) and social media giant Facebook (FB), was well as healthcare-sector highflyers Johnson & Johnson (JNJ) and Gilead Sciences (GILD).

Yet the momentum ETF’s recent underperformance has caused some to wonder if there is some turmoil under the surface of the major U.S. equity indices. The iShares MSCI USA Momentum Factor ETF is down 2.3% the past month, compared with a gain of 1.6% for the S&P 500.

The chart below shows the relative performance of the momentum ETF versus the S&P 500. The decline over the past month illustrates the underperformance of large-cap momentum stocks.

The March pullback in momentum stocks such as Netflix (NFLX), Priceline (PCLN) and Twitter (TWTR) has dealt a loss to investors chasing hot performers, Reuters reports. Some of these stocks have rich valuations as investors bet on future growth.

The question for investors is whether the recent weakness in high-momentum names is a harbinger for the overall market, or simply a normal rotation into more lower-valuation stocks and sectors as the Federal Reserve continues to taper its economic stimulus.

“The weakness in momentum stocks does have an implication for the broader market,” said Joshua Brown, vice president of investments at Fusion Analytics, in the Reuters story. “The best way to gauge general risk appetite is to look at momentum sectors.”

“It would normally be concerning to see this,” countered Frank Gretz, market analyst at brokerage Wellington Shields, in the article. “Instead, other companies are stepping up and new leaders are emerging. Enough is holding together that I haven’t given up on the bull market even with the leadership coming down.”

Barron’s over the weekend reported momentum stocks may get back on track, and that academic research has shown that the best-performing stocks generally continue their winning ways.

“After a spell in the market’s doghouse, these and other dented momentum shares are likely to resume their advance, bolstered by an improving economy,” Barron’s reported.

Photo credit: Stronglight via Flickr Creative Commons

DISCLAIMER: The investments discussed are held in client accounts as of March 31st, 2013. These investments may or may not be currently held in client accounts.The information in this material is not intended to be personalized financial advice and should not be solely relied on for making financial decisions. All investments involve risk, the amount of which may vary significantly. Past performance is no guarantee of future results.