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What the momentum trade tells us about the stock market

Data: FactSet; Chart: Matt Phillips/AxiosThe momentum trade is having a terrible start to the second half. Why it matters: Momentum shares drove the market gains early in the year, and it will be harder for the rally to continue without their participation.How it works: Momentum is one of the "factors" some mathematically minded investors, known as quants, use to describe and organize the market according to certain well-understood market trends.Momentum stocks are defined, more or less, as shares that have been going up — and outperforming the broader market — for roughly a year.The academic research that quantitative investing is based on has found that such trends have a tendency to persist. In other words, a momentum stock that has been rising is mathematically more likely to keep on rising than the market as a whole. (Here's a highly cited paper documenting the phenomenon across different kinds of markets.)Catch up quick: Momentum has been one of the best-performing market trends of the last year. A broadly followed ETF from iShares built on stocks that qualify as "momentum" trades is up roughly 33% over the last 12 months, handily outperforming the S&P 500's 20% gain. Zoom in: It should come as no surprise that chip and memory stocks have been some of the biggest contributors to the outperformance of the momentum factor in 2026. Micron Technology is up more than 200%, and Intel is not far behind. And Advanced Micro Devices is up more than 140%. Yes, but: Since July, however, momentum is one of the worst-performing factors. Why?Reality check: While factors can be a helpful way to describe the kinds of stocks responsible for the market rising or falling, they're pretty unhelpful as a tool to understand why different factors have been doing better or worse. That sort of analysis still requires a bit of good, old-fashioned noggin-eering. The intrigue: The biggest clue, to my mind, can be found in the timing of the momentum selloff, which began shortly after the Federal Reserve's latest interest rate decision. Interest rates rose in the days after the June 18 decision to hold rates steady.The market seemed to view the Fed under new chairman Kevin Warsh as more likely to raise interest rates — or less likely to cut them — than previously expected. Shorter-term interest rates rose, topping out on June 22, which also happens to be the day when the momentum selloff started. By the numbers: Through their worst moments on Tuesday, the iShares MTUM fund was down a bit more than 11%, which roughly meets the standard of a "correction." (Typically, considered a 10% drop.) The ETF is now down roughly 8% for the month, which would be its worst monthly showing since early 2022, when the Fed was also sending signals that it was about to ratchet up rates to beat back the post-COVID inflation. Context: This is pretty much in keeping with research on how interest rates affect different market factors. The TL;DR is pretty much that the momentum factor struggles when there is a transition in interest rates, from falling to rising or rising to falling.In other words, it matters less that interest rates are high or low, and more that the general backdrop is shifting, often because of economic surprises or shifts in the behavior of the Federal Reserve, which the market seems to be pricing in under Warsh. Such transitional moments can upset the proverbial apple cart that has been carrying the market trend for a while, triggering "momentum unwinds" like the one we're seeing.What we're watching: Oil prices, which were up Wednesday on hostilities with Iran. They're important for inflation, which is super important to the Fed, which — as we described above — can be extremely important to the stock market.