Author Details

Waman Virgaonkar

Waman Virgaonkar
Senior Associate, Core Equity Research

Hitendra D Varsani

Hitendra D Varsani
Executive Director, Equity Core Research

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Factors in Focus: Momentum hits a valuation speed bump

  • In the third quarter of 2019, quality and low volatility outperformed across all regions, while the performance of other factors was mixed.
  • As the quarter began, momentum was highly overvalued compared to its own past, and thus, the momentum-value spread saw one of the largest corrections in history over the summer.
  • Heading into the fourth quarter, our adaptive multi-factor model showed a mild overweight to value and a mild underweight to yield, with all other factors neutral.

As we wrote in the last Factors in Focus, our macro cycle indicators at the end of June showed the global economy slowing down. Factor performance in the third quarter was in line with that.

Both quality and low volatility outperformed in all regions, while yield, value and size fared less well. Escalating trade tensions between the U.S. and China, and uncertainty around Brexit, led investors to adopt a defensive outlook, as did weakness in the U.S. PMI, contracting retail sales in the U.K. and negative GDP growth in Germany.


Low-volatility and quality indexes outperformed in the third quarter

The table shows regional variations of the MSCI ACWI Minimum Volatility Index (USD), MSCI ACWI High Dividend Yield Index, MSCI ACWI Quality Index, MSCI ACWI Momentum Index, MSCI ACWI Enhanced Value Index and MSCI ACWI Equal Weighted Index from June 28, 2019, to Sept. 30, 2019.

As we noted in a recent blog post, however, momentum had an intense sell-off this September, as defensive factors pulled back and pro-cyclical factors, particularly value, posted positive returns.


From defensive to pro-cyclical through Q3

The table shows active return (%) performance of the MSCI ACWI Minimum Volatility Index (USD), MSCI ACWI High Dividend Yield Index, MSCI ACWI Quality Index, MSCI ACWI Momentum Index, MSCI ACWI Enhanced Value Index and MSCI ACWI Equal Weighted Index for each month and full quarter from June 28, 2019, to Sept. 30, 2019.


From momentum to value

The relative move between momentum and value was one of the biggest shifts over the last 20 years, as seen in the exhibit above. The last time a weekly return spread of this magnitude occurred between the two factors was during the global financial crisis in late 2008.


Momentum-value standardized spread — quant quake or shake?

The exhibit shows weekly spread-return (%) performance of the MSCI World Momentum Index vs. the MSCI World Enhanced Value Index. The plot shows the momentum-value weekly return z-score. Z-scores are calculated using an expanding window from January 1999.

The exhibit below shows the rarity of these occurences across regions; and, for context on how expensive or cheap the spread was, we also show the valuation ratio between momentum and value. It’s clear the recent drawdown patterns were more pronouced in regions where the valuation ratios between the two factors was most stretched. A positive change in market sentiment in early September triggered the U.S. 10-year Treasury yield to rise from 1.5% to 1.9%, reversing a year of decline. It also led to underformance among defensive stocks and a switch from overvalued and overcrowded momentum stocks to value.


Price momentum had negative performance across regions

September 2019 Momentum – value Momentum/value
MSCI Indexes Max September weekly z-score return No. of previous occurrences that exceeded September 2019 Current valuation ratio (forward P/E) Percentile of ratio (forward P/E)
ACWI -3.69 1 2.62 0.94
World -4.14 1 2.51 0.94
Emerging Markets -1.73 17 2.00 0.76
USA -4.48 0 2.27 0.94
Europe -3.33 2 1.92 0.89
AC Asia ex Japan -1.22 55 2.13 0.90
Japan -2.07 22 2.40 0.99

The table shows the maximum value of z-scores of spread of weekly returns of the MSCI Regional Momentum Index vs. the MSCI Regional Enhanced Value Index in September 2019, the number of days this value was exceeded in the entire history from January 1999 to September 2019, the ratio of the valuation ratio (forward P/E) of those indexes and their historical percentiles.

How did other factors compare? In the exhibit below, we show the ratio of the price/forward earnings of the defensive factor indexes to the value index. While we observe similar patterns among quality and low volatility relative to value, the magnitude of valuation differentials was less pronouced than that of momentum.


Momentum was more overvalued than defensive factors

Shows the ratio of price/forward earnings of MSCI World Momentum Index, MSCI World Quality Index and MSCI World Minimum Volatility Index (USD), over the price/forward earnings of MSCI World Enhanced Value Index from Jan. 1, 2010, to Sept. 30, 2019.


What about the fourth quarter?

  • As of Sept. 28, 2019, our adaptive multi-factor model1 showed the following exposures across the four pillars:
  • Macro cycle indicated a mixed signal between slowdown and recovery and overweighted low volatility, quality and value, based on the Chicago National Activity Index, the Federal Reserve Bank of Philadelphia ADS Index and the PMI.
  • Valuation overweighted value, low size and yield, based on the valuation gap compared to an equal-weighted factor mix in the context of nearly 30 years of a factor’s history.
  • Momentum selected momentum, quality and low volatility, based on the last six months’ relative performance.
  • Market sentiment showed a mild overweight to low size, momentum and value, based on contained credit spreads and an upward-sloping Cboe Volatility Index (VIX) term structure at the time of reference.


Exposures from MSCI’s adaptive multi-factor allocation model

As of Sept. 30, 2019. Positive exposures are denoted as + or ++, negative as - or --, neutral as N.

While value underperformed across developed and emerging markets year to date, our adaptive multi-factor model suggested the potential for value to gain speed, as indicated by the exhibit above.



1Varsani, H. and Jain, V. 2018. “Adaptive multi-factor allocation.” MSCI Research Insight.



Further Reading

Factors in Focus: Dynamic short term, strategic long term

Factors in Focus: Risky start. Quality finish.

Factors in Focus: Navigating turbulent markets

Adaptive multi-factor allocation

A defensive approach to factor portfolios