By Jacob Sonenshine
Just when everyone thinks the momentum trade is here to stay forever is exactly when the smart investor thinks again -- especially with tech stocks.
Right now, chip companies are the best examples of names that took off this spring after February's steep pullback.
One of the best ways to learn about the momentum trade is through the iShares Edge MSCI USA Momentum Factor Exchange-Traded Fund, which is heavily weighted to the tech sector. It selects the 125 stocks with the highest ratios of three-month price returns minus the three-month Treasury yield compared to their volatility levels of the past three years. In short, this shows strong gains without the extreme volatility that those returns usually come with.
The momentum ETF is up 21% this year, touching a new 52-week high in mid-May, driven by its tech holdings such as Advanced Micro Devices, Intel, Micron Technology, Lam Research, and Applied Materials. These stocks have exploded higher as the Big Tech internet and software companies increase their AI data center investments -- chips and related equipment -- at a pace far faster than Wall Street imagined just months ago.
But there's another number to consider besides returns. It's "turnover" rate, the percentage of momentum names that been replaced with new ones.
A basket of momentum stocks that 22V Research's Dennis DeBusscherre tracks has seen its turnover rate rise to almost 5%, up from 2% early in the year. The rate is above its 75th percentile dating back about a decade.
This shows the names that have lost their luster. In the context of momentum, it means those stocks are no longer gaining enough in price to justify their increasing volatility.
Volatility in the past month for these stocks has roughly doubled -- making many of them far less attractive. While less attractive doesn't immediately translate to massive declines anytime soon, it does increase the risk of slides.
Investing is, after all, about managing risk. And DeBusscherre is warning of what he calls "price momentum crashes."
Such risk makes sense from a fundamental perspective. Companies that make memory chips and equipment -- Micron, Western Digital, Teradyne -- could see a dramatic drop in demand and price if customers stop ordering chips, making the supply look too big.
The massive tech services companies could reduce the growth of their investments faster than the market anticipates after they build out all of the data centers they need, which would hurt demand for the breadth of these tech hardware and industrial manufacturers.
That would hit the stocks hard. Sure, recent sales and earnings growth rates justify high valuations, but not if growth slows. The momentum fund's forward price/earnings, at about 23 times, is in the middle of its range in the past three years. While it doesn't look as expensive as when it was at its richest level, it's also far from cheap -- especially if earnings outlooks disappoint.
It's entirely possible that "stock prices are ahead of the fundamentals when it comes to the Data Center build out and AI-related stocks," writes Trivariate Research's Adam Parker, who acknowledges that earnings and outlooks have looked strong so far.
To put it plainly, now isn't the time to buy these names. They're partying, but the smart investor won't join a buzzing party after midnight.
Write to Jacob Sonenshine at jacob.sonenshine@barrons.com
This content was created by Barron's, which is operated by Dow Jones & Co. Barron's is published independently from Dow Jones Newswires and The Wall Street Journal.
(END) Dow Jones Newswires
May 26, 2026 13:13 ET (17:13 GMT)
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