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Why Momentum Stocks Could Underperform

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Apr. 2 2015, Published 9:18 a.m. ET

The recent pickup in volatility is a useful reminder of the risks lurking in momentum stocks, both traditional ones and less-obvious “momentum” names.

risks lurking in momentum stocks

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Market Realist – A stronger dollar, lofty valuations, and the looming rate hike are causing higher volatility in US stocks.

The graph above shows the CBOE volatility index, or VIX (VXX)(XIV), which is also known as the “fear gauge.” The VIX measures the market’s expectation of volatility in stocks (SPY)(VOO) over the next 30 days.

The VIX remained low for most of 2014 as the US economy was doing well and market shocks were minimal. However, since October 2014, the index spiked due to softening global growth (ACWI). This year, so far, the VIX has been higher than last year, as the graph suggests. The average level for the whole of last year was 14.2. The average for this year so far is 16.5. Volatility could remain high this year, as equities are facing many headwinds—including a stronger dollar (UUP), lofty valuations, the possibility of a rate hike, and soft global growth.

There are a few sectors that have outperformed since the start of last year. This series will focus on why these sectors could underperform. The markets have factored in high expectations for these sectors, which we think won’t materialize.

Also, recent economic data suggest that the US GDP (gross domestic product) growth rate could slow in 1Q15. This outlook means that stock selection is key, going forward, especially since certain sectors are appearing frothy.

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