Momentum investors beware — the recent rise in market volatility could make for challenging times for momentum stocks, while quality growth plays could emerge as the market’s new leadership group, according to a report in Barron’s. Momentum investment strategies invest in companies exhibiting strong price momentum, but that momentum may or may not be supported by the underlying fundamentals, which can lead to declines when they fall out of favor. According to Bank of America strategist Savita Subramanian, “momentum stocks traded at a 50% premium to the market before the selloff, versus a historical average premium of 20%”, but once momentum stocks peak in a particular market cycle, they fall, on average, 27%. One indicator investors can look at is the CBOE Volatility index, or VIX, says Subramanian. Once the VIX moves over $25, momentum stocks have tended to underperform the market by a wide margin and it currently hovers just above that level.
So where do investors go when momentum starts to underperform? Growth companies could be one group that starts to take the lead. “When there’s a scarcity of growth in the economy, investors go to names they know can grow on their own,” says Joe Fath, manager of the $45 billion T. Rowe Price Growth Stock fund. Below is a list of some growth companies he thinks may be worthy of consideration.