Momentum Trading: The Short-Term Steamroller of the Market—Institutional Investors Should Beware the Trend-Chasing Trap

Momentum Trading: The Market’s Short-Term Steamroller—Institutional Investors Should Beware of the Trend-Chasing Trap

In the world of investing, blindly following market trends is known as “momentum trading.” When a momentum rally begins, fundamental-based stock pickers often underperform their benchmarks, disappointed clients withdraw capital, and value fund managers face enormous pressure to capitulate. The struggles of the UK investment firm Fundsmith vividly illustrate this dilemma. However, when the bubble bursts, belated trend-following decisions usually come at a high cost.

Market Background: Low Volatility and Excess Liquidity Drive Trend Reinforcement

The current global economic environment features low inflation, low interest rates (although major central banks have entered a rate-hiking cycle, real rates remain at historic lows), and ample liquidity. IMF data shows that global GDP growth is expected to remain around 3.2% in 2026, but growth divergence is pronounced. On the policy front, the monetary policy paces of the Fed, the ECB, and the Bank of Japan are out of sync, leading to frequent arbitrage capital flows.

Against this backdrop, market volatility is at historic lows (the VIX index has long been below 15), providing ideal soil for momentum strategies. Quantitative funds and high-frequency traders extensively use trend-following algorithms, further amplifying stock price momentum. According to BlackRock’s research, the momentum factor has generated excess returns of over 10% in U.S. stocks over the past two years, while the value factor has continued to lag.

Current Capital Flows: Momentum Factor Becomes Institutional Favorite

Capital is concentrating into a handful of mega-cap stocks and popular themes. As of the second quarter of 2026, over 40% of global ETF inflows went to technology, artificial intelligence, and clean energy thematic funds. At the individual stock level, “momentum stars” such as Applovin, GE Vernova, and TSMC continue to see their valuations climb, with P/E ratios detached from fundamental support.

Institutional investors face severe performance pressure. To narrow the gap with benchmarks, pension funds and endowments are forced to increase their holdings of momentum stocks. Goldman Sachs data shows that in the first half of 2026, the allocation to momentum strategies in global mutual funds rose to an all-time high, while allocation to value strategies fell to a ten-year low. Family offices are also joining the trend chase, pouring more funds into private equity and alternative assets in search of short-term returns.

Investment Logic Analysis: Why Is Momentum So Persistent?

The prevalence of momentum trading stems from three structural factors:

1. Behavioral Finance Biases: Investors have a “trend confirmation” bias, tending to believe that strong stocks will continue to strengthen. Institutional investors’ evaluation cycles are typically quarterly or annual, forcing them to chase short-term trends to avoid falling behind in rankings.

2. Quantitative Strategies Dominate the Market: Low-latency trading and factor investment models used by quantitative funds amplify the momentum effect. According to Morgan Stanley estimates, algorithmic trading now accounts for over 70% of U.S. stock trading volume. When momentum signals trigger buy orders, stock prices rise in a self-fulfilling manner.3. Safe-haven demand amid macro uncertainty: Against the backdrop of persistent inflation and geopolitical risks, investors are more inclined to hold assets that have demonstrated resilience, forming a "the strong get stronger" pattern.

However, as investment guru Jeremy Grantham noted: "Momentum is the yin of value, value is the yang of momentum." When value trades underperform, allocating to momentum stocks can indeed narrow the gap between a portfolio and its benchmark. But the core question is: has the current momentum premium become excessively overstretched?

Risk Factors: A Repeat of Momentum Crashes in History

The biggest risk of momentum strategies is a "momentum crash"—when crowded long positions reverse, the ensuing decline is often brutal. Historically, the tech bubble in 2000, the financial stock crash in 2008, and the growth stock plunge in 2022 are all classic examples of momentum reversals.

Current risks are concentrated on:

• Extreme valuation: The median price-to-earnings ratio of momentum stocks has exceeded 40x, while that of value stocks is only 12x. The valuation gap is the widest in nearly two decades.
• Liquidity inflection point: If central banks continue to tighten monetary policy, unwinding carry trades could trigger a stampede. The BIS warns that global leverage remains high, and risk is accumulating in interest-rate-sensitive assets.
• Policy and regulatory risk: Antitrust investigations into big tech in the US and Europe are heating up, potentially undermining the narrative underpinning the AI theme.
• Geopolitical disruption: The Taiwan Strait situation, the Middle East conflict, or a surge in commodity prices could break the fragile balance of current trends.

The case of Fundsmith is worth considering: The fund has consistently bought high-quality companies at reasonable prices, but during momentum-driven markets, it significantly underperformed its benchmark. Client redemption pressure forced the fund manager to adjust strategy—an adjustment that often occurs near the top of a trend. John Llewellyn, former chief economist at Lehman Brothers, noted: "The biggest mistake institutional investors make is abandoning discipline late in the trend."

Long-Term Outlook: Asset Allocation Insights from a Long-Term Perspective

Looking ahead 3–10 years, we believe the appeal of momentum strategies will gradually fade, while the long-term logic of value investing and thematic investing will reassert itself.

First, an aging population, high debt levels, and the cost of the energy transition will push the neutral real interest rate higher, which is unfavorable for momentum stocks that rely on high valuations and low discount rates. The OECD projects that global real interest rates will rise by 1–2 percentage points over the next decade.

Second, although artificial intelligence and clean energy are long-term themes, current valuations have already over-discounted future cash flows. McKinsey’s research shows that technology maturity curves often go through stages of "inflated expectations" to "trough of disillusionment." Jumping in too early with a momentum approach may lead to permanent capital loss.

• For institutional investors, we recommend:- Maintain portfolio diversification: Use momentum factor as a satellite allocation, not a core position. Reference Bridgewater's risk parity framework to balance growth, inflation, and safe-haven assets.
• Contrarian allocation to value: When the valuation discount of value factor reaches historical extremes, increase weight in undervalued stocks. UBS expects value stocks to outperform growth stocks by 3% annualized over the next five years.
• Focus on alternative cash flow assets: Assets that generate stable cash flows, such as infrastructure and energy royalties, provide downside protection during momentum crashes. Sovereign wealth funds like Norway's GPFG have increased such allocations.

In summary, momentum trading is the market's "short-term steamroller," but long-term investors should not follow the steamroller to pick up coins. As Grantham cautioned: avoid the "short-termism trap," and adhere to asset allocation based on long-term economic and industry logic to achieve steady returns amid extreme market volatility.