The stocks that powered the market's first-half gains are now pulling the market in the opposite direction. A broad momentum-focused exchange-traded fund has fallen roughly 8% this month, marking its worst performance since early 2022, when the Federal Reserve was last signaling aggressive rate increases.
The timing is no accident. The selloff in momentum stocks began in late June, shortly after the Fed's decision to hold interest rates steady, but market expectations shifted sharply toward future rate hikes under new Federal Reserve chairman Kevin Warsh. Short-term interest rates jumped in response, and momentum stocks have been sliding ever since.
Momentum investing is a mathematical approach used by quantitative investors to identify and track stocks that have consistently outperformed the broader market over roughly a year. Academic research shows these trends tend to persist: a stock that has been rising is statistically more likely to keep rising than the market overall. The iShares momentum ETF, a widely followed barometer for this strategy, gained roughly 33% over the past 12 months compared to the S&P 500's 20% return.
Semiconductor stocks drove much of that outperformance. Micron Technology surged more than 200%, Advanced Micro Devices jumped over 140%, and Intel posted triple-digit gains. These gains made momentum one of the market's most reliable engines heading into the second half of the year.
But the strategy's vulnerability to interest rate shifts has now become painfully clear. Momentum stocks struggle not when rates are inherently high or low, but when the interest rate environment is changing. Those transition periods create instability that can rapidly unwind the very trends momentum investors rely on.
The current selloff reflects how the market is repricing expectations for Fed policy. The shift from anticipating rate cuts to bracing for rate hikes has rippled through the momentum trade, suggesting the broader rally cannot continue without these stocks leading the charge. Oil prices, which moved higher this week on geopolitical tensions, will be another crucial variable, since energy costs directly influence inflation readings that shape Fed thinking.
What happens next depends largely on whether those rate expectations stabilize or continue to shift. If the market settles into a conviction about where rates are headed, momentum stocks could recover their footing. If uncertainty persists, the weakness could spread to other corners of the market that have also benefited from the year's gains.
Author James Rodriguez: "The momentum unwind is a reminder that even the most powerful market trends are hostage to the Fed's next move."
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