Momentum stocks like Palantir are off to a strong start in 2025 - even after DeepSeek disrupted the 'Magnificent Seven'

Dow Jones
12 Feb

MW Momentum stocks like Palantir are off to a strong start in 2025 - even after DeepSeek disrupted the 'Magnificent Seven'

By Joseph Adinolfi

Funds and indexes tracking Wall Street's momentum trade have continued to outperform this year - even as some of their top holdings from 2024 have struggled

Big Tech stocks like Apple Inc. $(AAPL)$, Tesla Inc. $(TSLA)$ and Nvidia Corp. $(NVDA)$ are off to a rocky start in 2025. But Wall Street's momentum machine has kept on churning, even without their help.

After wrapping up what was, by some measures, their strongest year in nearly two decades, momentum stocks are off to the races once again in 2025 - even as Big Tech, formerly a stalwart of the momentum trade, has struggled. Through Monday's close, the Roundhill Magnificent Seven ETF MAGS, which tracks shares of the seven companies known as the "Magnificent Seven" on an equal-weighted basis, has gained just 0.4% since the start of 2025.

By comparison, the S&P 500 SPX was up 3.1% year to date, while the iShares Edge MSCI USA Momentum Factor ETF MTUM - the largest momentum-factor ETF in the U.S., with more than $16 billion under management - had gained nearly 10%. The ETF notched its sixth record close of 2025 on Monday when it finished at $227.08 a share, although it gave back some of those gains on Tuesday, FactSet data showed.

That comes on the heels of a nearly 32% gain for the momentum ETF in 2024, its strongest showing since 2017, according to FactSet data. By comparison, the S&P 500 gained 23.3% in 2024, excluding dividends.

Other momentum portfolios did even better, relatively speaking; one long-short momentum-factor model developed by SimCorp saw its strongest year since 2007, according to Melissa Brown, managing director of investment-decision research at SimCorp. This portfolio incorporates 3,000 stocks and represents "pure" exposure to the momentum factor, Brown said.

Perhaps the most notable aspect of this shift, according to Brown, is that the Magnificent Seven stocks had already started to lose momentum before the DeepSeek-inspired selloff that shook U.S. markets in late January. But fortunately, other stocks have emerged to take the leadership baton.

What is a 'factor'?

On the most basic level, factor-based investing involves building a portfolio based on one specific attribute that defines each of your investments, said Callie Cox, chief market strategist at Ritholtz Wealth Management.

It involves optimizing an investment portfolio for one - or a few - different characteristics that an investor believes can outperform over a certain period of time.

Factor analysis can also be used to help asset managers develop truly diversified portfolios which, over time, can deliver more robust returns relative to the risk assumed by their investors. Sometimes, simply choosing stocks from a number of different sectors isn't enough to achieve true diversification, and some managers are careful to limit their exposure to any one factor or style.

While a factor can be practically any characteristic common to a group of stocks, five have become particularly ingrained in the U.S. investment-management industry, according to Bob Hum, U.S. head of factor and outcome ETFs at BlackRock. Those are: Quality, value, momentum, size and volatility.

Even when measured against a more comprehensive list, momentum outdid all of its rivals in 2024 and is shaping up for a repeat in 2025, according to data shared with MarketWatch by Piper Sandler's Michael Kantrowitz. That comes after a relatively rough stretch for the momentum trade in 2022 and 2023.

        Style              Driver          2025 Performance 
   Momentum        Momentum                           7.01 % 
   Revisions       3M EPS Revision                    5.24 % 
   Size            Market Capitalization              4.06 % 
   Growth          Growth                             2.22 % 
   Share Buybacks  1Y Share Buyback                   0.26 % 
   Volatility      Low Volatility                     -0.04% 
   ESG             ESG Disclosure Score               -0.47% 
   Quality         Quality                            -0.61% 
   Trade Activity  Liquidity                          -1.19% 
   Short Interest  SI Days to Cover                   -1.98% 
   Dividends       Dividend Yield                     -2.63% 
   Value           Value                              -4.38% 

Source: Piper Sandler, Bloomberg

        Style              Driver          2024 Performance 
   Momentum        Momentum                          15.17 % 
   Size            Market Capitalization              9.48 % 
   Revisions       3M EPS Revision                    6.98 % 
   Volatility      Low Volatility                     5.73 % 
   Quality         Quality                            3.79 % 
   ESG             ESG Disclosure Score               3.60 % 
   Dividends       Dividend Yield                     1.37 % 
   Growth          Growth                             0.71 % 
   Share Buybacks  1Y Share Buyback                   0.50 % 
   Short Interest  SI Days to Cover                   -3.52% 
   Value           Value                              -4.71% 
   Trade Activity  Liquidity                          -4.94% 

Source: Piper Sandler, Bloomberg

What does 'momentum investing' mean?

Put simply, momentum investing involves buying shares of stocks that have delivered the strongest risk-adjusted returns over the past three months to a year, while shorting - that is, betting against - shares of those that have done the worst.

A landmark research paper authored by Narasimhan Jegadeesh and Sheridan Titman and published in the Journal of Finance in 1993 demonstrated that this approach would have helped an investor deliver reliable outperformance over time. While the MTUM ETF is a long-only product, many other factor models include long and short positions.

Since then, others have found that the same principle applies to foreign stocks and even other asset classes like bonds.

The question of why momentum investing works is a little bit more murky. One complication that has stymied academics: Momentum's long-term success appears to contradict the weak form of the efficient-market hypothesis, which stipulates that past market trends can't reliably anticipate future returns.

Some researchers have posited that momentum's success is evidence that it takes time for financial markets to fully absorb new information, SimCorp's Brown said.

BlackRock's Hum has a theory of his own: People like to buy what is already working, regardless of the fundamentals.

"The idea is that when stocks start to trend, people start to buy. Call it the 'FOMO' effect: More and more investors start to pile in, and that is why this factor has been rewarded over time," Hum said.

Whatever the reason, the factor's malleability has been critical to its success over the past year.

The iShares momentum ETF, and the MSCI index that it tracks, is reconstituted every quarter - so every three months, up to 30% of its holdings can be swapped out. This has helped it to adjust to accommodate changes in market leadership.

For example, over the last few quarters, financials have seen their weighting in MTUM climb to 24%. That is 10 percentage points greater than their weighting in the S&P 500.

"Financials have been trending very well lately," said John Davi, founder and chief executive of Astoria Portfolio Advisors, during an interview with MarketWatch.

At the same time, the ETF has steadily reduced its holdings in Big Tech stocks like Apple and Microsoft Corp. $(MSFT)$, which have lagged the S&P 500 over the past six months, Hum noted.

It is not uncommon for MTUM to see the 125 stocks in its portfolio completely turn over from year to year, he added.

The trading environment that prevailed in 2024, characterized by steady trends and gradual shifts in leadership, has been particularly favorable for the momentum trade, Hum told MarketWatch.

"When we see trends in the markets like we've seen, especially when they're over a prolonged period, that's really beneficial to the momentum factor. When you see trends change quickly, that's going to be more challenging," he said during an interview on Tuesday.

Shifting away from Big Tech

A quick look at how MTUM's top holdings have evolved over the past two years helps to underscore this sometimes-rapid pace of turnover.

As of late 2022, the ETF was dominated by energy stocks and companies in the defensive healthcare and consumer-staples sectors. That makes sense, considering that energy stocks soared in 2022 while the broader market struggled. The S&P 500 eventually clinched its worst calendar-year performance since 2008 that year, FactSet data showed.

     MTUM Top 10 Holdings    12/31/2022 
             Name            Weight (%) 
   Eli Lilly and Co.                5.17 
   UnitedHealth Group Inc.          5.11 
   Exxon Mobil Corp.                5.03 
   Chevron Corp.                    5.01 
   Merck & Co. Inc.                 3.87 
   AbbVie Inc.                      3.40 
   ConocoPhillips                   2.79 
   PepsiCo Inc.                     2.78 
   Amgen Inc.                       2.36 
   McDonald's Corp.                 2.29 

Source: BlackRock, FactSet

By the end of 2023, the ETF's top holdings had been almost completely reconstituted to reflect the dominance of the Magnificent Seven, which were responsible for an outsize share of the S&P 500's gains that year.

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February 12, 2025 07:00 ET (12:00 GMT)

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