How to profit from the end of momentum

If you think the market's due for a long drift downward, here's the investment for you.

By StreetAuthority Apr 15, 2014 4:10PM
Caption: Analyzing stock market from computer screen
Credit: © MicroWorks/Getty ImagesBy David Goodboy

"The times, they are a-changing."

Watching the stock market closely over the last week brought Bob Dylan's words to mind. The Dow Jones industrials ($INDU) plunged over 600 points in six trading sessions, and the high-flying Nasdaq Composite Index ($COMPX) sustained its largest drop in over two years.

What's more, five of the 14 IPOs slated for the past two weeks postponed their launches due to the sell-off. The majority of this selling was by hedge funds slashing their risk exposure, according to The Wall Street Journal, sending shivers of fear into even the most hardened of stock market players.

This selling is different than what we witnessed in January. The January selling was triggered by the fear of a change in Federal Reserve policy and simple profit-taking. Last year's bull market prompted many investors to simply wait until January to cash in so they could delay paying taxes on their fat gains for another year.

In contrast, the current selling appears to be a shift from high-flying growth stocks to defensive stocks. I think this selling is signaling that the smart money is starting to position itself for a flat to down stock market in 2014.

Biotechs and other high-momentum stocks like many internet/high tech names have been slammed lower -- but stodgy stocks like McDonald's (MCD), IBM (IBM) and Procter & Gamble (PG) have been inching higher.

In addition, hedge funds have reduced their overall long exposure to equities from 58 percent to 46 percent, according to Credit Suisse. In the United States, net long positions are at their lowest levels since August 2012.

Most telling is that the CBOE Volatility Index (VIX), also known as the fear gauge, had soared 30 percent since April 2, to just over 17, before drifting back down.

Believe it or not, this is great news.

Savvy investors welcome this shift for two primary reasons. First, it may allow stocks to be purchased at a sharp discount from their recent heady highs. Second, investors can profit from the fear by shorting stocks.

One of the most amazing things about the stock market is it really doesn't matter which way it moves -- active investors can still make money. While many passive investors are trapped in long-only mutual funds and similar products, active investors retain the flexibility to capture profits in both bullish and bearish markets.

I expect the markets to continue downward, closing the year flat or lower. This will be my bias until the market proves it wrong -- namely, until the major indices take out the all-time highs.

I'm not yet expecting a sharp plunge or crash from here -- just a slow drift downward into the fall months. This certainly doesn't mean stock will not rally during the slow grind downward. They certainly may -- but the edge will be shorting any sharp rallies.

Obviously, in these conditions, searching for shorting opportunities in the previous high-flying momentum stocks makes sense.

My favorite short play in these conditions is to short the iShares MSCI USA Momentum Factor ETF (MTUM). Built on mid- and large-cap momentum stocks, MTUM is down almost 4 percent for the year. Containing 125 stocks that exhibit higher momentum characteristics than the overall market, this ETF is composed primarily of the same stocks that hedge funds are in the process of dumping.

Source: BlackRock

Launched last April, the ETF is relatively new, but it has grown to nearly $195 million in net assets, representing a portfolio with a total market cap of $3.8 trillion. Due to its composition, I think MTUM will continue to be pressured downward even if the overall market regains its footing.

Risks to consider: Shorting is dangerous since it goes against the inherent upward drift of stocks. It can be very lucrative since markets often sell off faster than they climb higher. While I expect this shift away from the momentum stocks to continue, it's important to note that the fundamentals supporting the overall stock market remain intact. Always use stop-loss orders and diversify when investing. This is particularly critical if you have short positions.


Action to take:
Shorting the MTUM ETF within the channel makes good investing sense right now. Remember to expect updrafts in price on the way to the targeted $51. I will remain confident in the position until the stops at $61.50 are hit.

15Comments
Apr 15, 2014 10:03PM
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This "momentum" has been more perception than reality.  And for those of you who insist on valuing perception, just  remember, profits on paper are meaningless until you actually trade them for something tangible.  Only a fool counts his money and brags about his winnings while he's still inside the casino. 
Apr 15, 2014 8:43PM
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First... WHAT momentum? Having the Federal Reserve constantly bail the markets because dead business platforms can't do enterprise, isn't movement, it's perpetual resuscitation. 
Second... WHERE does one find safe harbor for fake money? Your wealth is predicated on printing, not earning and none of the fiat money has assets in backing. 
Third... WHO do you think you are? Just because you made money in markets- essentially given to you, what do you know about venture, enterprise and genuine Risk? Probably less than delusional thinking imagines you do. 
Fourth... WOULD it not make sense that holders of game tokens get the bill for the damage done? You can bet on that one.
Fifth... WHEN the world collapse, you are likely the first people the rest hunt down because you are the possessor of the game tokens, not anybody actually doing the world any good.

So long, suckers. 
Apr 16, 2014 8:12AM
Apr 15, 2014 11:06PM
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We are still a long way from bottom. Even if we are at the bottom, it will take sometime to play out. 

The next quarter is not bright with so much uncertainties with lower forecast across the board. The stocks are still overvalued.

Wall Street has no confident and everything is about pump and dump to make quick profits.

Apr 16, 2014 3:19AM
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ummm, y'all just might want to peek at the futures markets for today and reassess that "end of momentum" thingie - isn't the best defense a good offense?
Apr 16, 2014 8:10AM
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You want to fight gravity be my guest.  Wages pegged to the USD are rising throughout the Asian Rim versus the Stagnant wages in America.  Unadmitted inflation is eating away at the average American and will only continue to lower their lifestyles and ability to purchase goods. Real profits will decline now for many years until you see made in the USA suddenly reappear.  Have you noticed how all these fatigued Internationals all seem to beat the street analysts by a penny?  Funny huh? Think a little manipulation could be involved?   We have always had problems in America but this constant fake everything just has to go away.

Apr 16, 2014 1:49PM
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Maybe only "ill gotten" profits are bad...?? Now we have to define i-l-l...
Apr 16, 2014 5:57AM
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Yesterday we saw a steady decline take an about-face and finish in the black. Since there wasn't any credible (is there any?) sudden change in events-- the rise from loss was absolutely bailing by the Federal Reserve. Our future OWES that fake cash. Isn't it time to Close the banks, end the Fed and to get RID of Wall Street? Where are the family sustaining jobs and stability careers. There is no such career as Financier and Economists should be made to wear clown costumes to work. They are. 
Apr 15, 2014 9:51PM
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My husband is an Independent financial advisor and he has been diversifying us away from equities over the past 8 months or so.  He actually has a sneaky tip for people where he says it is a good time to invest in your own home.  The growth in value is tax deferred and if you do it smartly it can be a high return on your investment.  We also have money in a LifeAnt insurance policy that nets us about 4-6% over the long term with tax deferred dividends.  We also have some high yield bonds and some municipal tax free bonds.  Basically keeping wealth after a big run in equity markets is all about different sources of savings and a more conservative steady approach.
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