Momentum Investing: Can You Outperform the Market?

While it's a common belief in financial markets that consistently outperforming market returns over the long term is challenging, the momentum investing strategy defies this notion. Recent academic research and market analyses suggest that this strategy, based on past performance, can offer significant advantages to investors, particularly under specific market conditions. It is specifically noted that following a recent drawdown, now might be an opportune time to invest in momentum funds.

Momentum investing is a strategy that typically involves buying stocks that have performed well over the previous three to twelve months, believing that this upward trend will continue. Academic studies spanning over a century demonstrate that the momentum factor has worked strongly and consistently across both domestic and global stock markets. For instance, in the U.S. market, the highest momentum stocks have outperformed the lowest momentum stocks by a staggering average of 9 percentage points per year. The year 2026 has been a dynamic period for momentum strategies; the S&P 500 Momentum Index gained over 44% in the second quarter and is up 36% year-to-date, leading all other factor-based equity exposures. Popular momentum-based funds like the iShares MSCI USA Momentum Factor ETF (MTUM) have also delivered over 20% year-to-date returns.

However, the momentum strategy also carries the risk of sharp downturns. In July 2026, momentum stocks experienced a significant drawdown, marking their worst month since the financial crisis. A high-beta momentum basket created by Goldman Sachs fell by more than 30% from its peak, while some high-momentum stocks in the Russell 1000 Index (RUI) were down an average of 21.6% since the start of July. While fear of such momentum downturns is a primary reason many hesitate to invest in momentum funds, historical data indicates that these drawdowns are typically short-lived, followed by a strong tendency for recovery.

These market developments have amplified momentum's effectiveness, especially in the current environment characterized by AI-led growth and an “unusual divergence” between market winners and losers. In North American markets, the momentum factor generated the strongest signal, with a spread of approximately 9.5%, suggesting that recent winners have continued to outperform laggards. However, this divergence also introduces the risk of the market entering a broader consolidation phase. Geopolitical risks, particularly tensions in the Middle East, have influenced market sentiment and caused fluctuations in momentum.

For 2026 overall, the U.S. economy is expected to see modest growth, supported by AI-driven investments and fiscal spending, while the Federal Reserve is anticipated to proceed cautiously with interest rate cuts. This macroeconomic outlook supports the potential continuation of the bull market, though returns may be more tempered due to high valuations and potential market volatility. Experts note that momentum investing is one of the most powerful strategies to earn market-beating returns, especially during bull markets and secular growth trends.

Analysts and market experts emphasize that while the momentum factor experiences significant drawdowns, these are typically brief and followed by robust recoveries. For example, the Invesco S&P 500 Momentum ETF (SPMO) has historically shown average returns of 12.4% over three months and over 24% after one year following its past 10 correction periods. This suggests that the current drawdown could present an attractive entry point for long-term investors who can stomach volatility. However, it is crucial to remember that momentum funds carry a higher risk factor than value, dividend, and quality strategies, and are more vulnerable to sudden price downtrends.