Morgan Stanley IM: Momentum Ruled In 2024, But Reversal Likely In 2025

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Bottom Line

2024 has experienced one of the top momentum runs of the past thirty years. Historically, such strong performance has led to a near-full reversal in performance in the subsequent year, though the middling valuations of momentum stocks temper that conclusion somewhat. Odds are still 2-1 against momentum stocks for 2025.

Thus far in 2024, momentum has ruled more than any other factor. Sure, high growth and high quality stocks have outperformed low growth and junkier stocks, but high momentum stocks have exploded higher (relative to low momentum stocks). The current momentum run is one of the top momentum runs since 1995 (see Display 1), with high momentum stocks outperforming low momentum by +28% year-on-year as of Dec 11^th, a two standard-deviation event.

We define momentum as the quintile of stocks with the highest 12-month risk-adjusted returns vs. the quintile with the lowest returns.¹ So what does the current crop of high momentum stocks look like?

• It is a surprisingly well-diversified bunch of stocks with absolute performance of 36% over the past year, and with the highest weight in Broad Tech (27% of the basket) and Financials (24%, of which almost half are regional banks). Industrials and Healthcare are also well-represented (13% and 11%, respectively) though there are few Energy, Materials, and Consumer stocks (13% of the basket combined).
• High momentum stocks today are a marginally more expensive (18x) than the average stock (17x) but also have higher margins and a higher forecasted EPS growth rate.

Extreme performance (top decile), as we have seen in the past year, historically bodes poorly for future performance of high momentum stocks, most decisively if one looks out 6-12 months.

• “Top decile” performance for momentum is anything above +19% in one year. Once this has been reached (as it was in June 2024), the run typically continues for another 6 months. From start to finish, a top decile momentum run historically sees +35% performance over eleven months, then reverses almost fully (down -25%) in the subsequent 10 months (see Display 2). By comparison, the current momentum run has seen +28% performance over 12 months. If history is any guide, we would expect a substantial reversal in 2025.
• One moderating factor: high momentum stocks are only modestly expensive vs. low momentum stocks (58^th percentile of history) which, on its own, would point to average future performance. However, combined with the extreme performance of the past year, the odds are still 2 to 1 for a momentum reversal.

Bottom line: 2024 has experienced one of the top momentum runs of the past thirty years. Historically, such strong performance has led to a near-full reversal in performance in the subsequent year, though the middling valuations of momentum stocks temper that conclusion somewhat. Odds are still 2-1 against momentum stocks for 2025.

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¹ 50/50 equal & cap-weighted, and beta-adjusted. Momentum defined as 12m beta-adjusted return of each stock excluding the past month’s performance because high one-month returns are known to experience a subsequent one-month reversal.

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