Quality Is Now a Momentum Trade

In this article, Russ Koesterich discusses why the current momentum trade, despite stretched valuations, could continue.

Key takeaways

  • Year to date, technology related companies have been the market leaders, with an increased focus on the ability to generate cash-flow. From a style factor lens, momentum has been the winner.
  • Historically, this style has often been associated with more speculative, lower-quality parts of the market. Today, momentum names are increasingly high-quality businesses with consistent profitability – something investors are willing to pay a premium for.

Markets have been on a tear, driven by solid earnings and a benign economic backdrop. And while a chorus of commentators is increasingly pointing to a replay of the late 1990’s technology bubble, there is one important difference: cash flow generation. Today’s technology related market leaders are incredibly powerful businesses levered to long-term secular trends. While this does not guarantee perpetual dominance, and valuations do ultimately matter, we believe it can support the trend to continue in the near-term.

I last discussed the technology (tech) sector in November of last year. At the time the market was still trying to recover from last fall’s backup in U.S. long-term interest rates. My view at the time was that tech might provide a measure of safety in a volatile market.

While markets have rallied sharply since then, the same logic holds. Tech and tech-related names are still benefiting from the generation of high-quality cash-flow, something most investors prioritize in the current environment. Adding to this subset buying, year-to-date a new group of investors have been chasing this trend: momentum players (see Chart 1).