By Ian Salisbury

The past year was a great one for momentum stocks. This year, uncertainty around inflation and President-elect Donald Trump's policy priorities mean investors may want to look farther afield at assets like dividend stocks and left-behind sectors like energy and real estate.

Focusing on momentum -- the premise that stocks with price gains in the recent past will continue to see them in the near future -- was a winning strategy in 2024. The iShares MSCI USA Momentum Factor exchange-traded fund (ticker: MTUM), which owns stocks whose prices have risen in the past six- and 12-month periods, returned 33% for the year, compared with 25% for the S&P 500.

Investors shouldn't necessarily count on a repeat, according to a note on Monday from Morgan Stanley Wealth Management -- especially given the market's rocky performance in December, as progress on inflation stalled and initial optimism following the election wore off. Since Dec. 1, the momentum ETF has declined 3.2%, compared with less than 2% for the S&P 500.

"If momentum is fading, it signals that the market is moving from the anticipatory 'dream' phase to the 'show me' phase," wrote Morgan Stanley analyst Lisa Shalett. "We believe 2024 will be a 'show me' year, when ambitious earnings expectations and promises of stimulative fiscal largesse and deregulatory policy will generate idiosyncratic winners and losers."

Research firm Leuthold Group also raises doubts about momentum's prospects. In a note on Wednesday, it pointed out that momentum, 2024's top-performing strategy, beat the so-called dividend aristocrats -- which consist of companies that have raised their dividend payouts for at least 25 years, and which was the worst-performing of 10 factors that the firm tracks -- by nearly 40 percentage points.

Such a wide divergence is unusual and tends to occur "around periods during which the market was experiencing turmoil," such as the dot-com bubble, the 2008-09 financial crisis, and the Covid pandemic, the firm noted.

While Leuthold is still positive on momentum, it also recommends investors target companies that are growing their dividends, another factor it is bullish on and one that can add a measure of diversification since those companies tend to have a different risk profile than momentum stocks.

Vanguard Dividend Appreciation $(VIG.AU)$ and WisdomTree U.S. Quality Dividend Growth $(DGRW)$ are two popular ETFs that zero in on those stocks.

For its part, Morgan Stanley predicted active managers will do well in 2025 and recommended investors focus on several factors beyond momentum. Since mid-November, Shalett wrote, "we have added...large-cap value and mid-cap growth [to portfolios]. We believe they will be the biggest beneficiaries of the incoming Trump administration's focus on deregulation and tax cuts."

Morgan Stanley is also putting its money on a number of industries that could benefit from Trump administration policies, such as financials, energy, real estate, and domestically-focused materials and consumer-goods companies.

Energy and materials were both left behind in 2024's rally. Energy stocks have returned just 3% in the past 12 months, while materials are down 0.7%.

While Trump has promised policies that could lift both these sectors, his from-the-hip style and Republicans' razor-thin margin in the House adds a lot of uncertainty. On Monday, stock and bond markets were whiplashed when a news story suggested that the president-elect planned a narrowly tailored approach to tariffs -- until Trump disavowed it.

One in-fashion industry that could continue to thrive in 2025 is financials. The sector has returned 28% in the past year, beating the 27% returns of the broad market. While that outperformance puts these stocks in the momentum camp, they can look forward to a number of 2025 tailwinds.

Financial firms stand to gain from Trump's light-touch approach to financial regulation -- including both appointments at banking regulators that oversee them directly and a more laissez-faire approach to mergers, which could spur dealmaking at investment banks.

Banks may also be able to capitalize on interest-rate shifts. While investors are forecasting shallower declines in short-term rates than they did just a few months ago, longer-term rates have been rising, leading to a steeper yield curve. That could benefit banks, which profit by borrowing money at short-term rates and lending it out at longer-term ones.

Write to Ian Salisbury at ian.salisbury@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.

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January 08, 2025 16:26 ET (21:26 GMT)

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