Bank of America Analysts Suggest Buying Momentum Equities, Predict 5% Gain

Bank of America's trading desk is recommending that clients buy US momentum equities, with the view that the sector is now attractively priced after a recent profit-taking episode.

Last week, the bank's collection of US momentum shares closed more than 10% below its June 25 high, after a selloff where investors reduced holdings and systematic trading strategies cashed in. As a result, the index is heading for its second-poorest July performance in ten years.

The momentum factor, which selects stocks based on recent price performance, has been a popular strategy among investors, particularly in tech-heavy markets. The current pullback, while severe, fits a typical pattern of mid-year corrections that have historically offered buying opportunities. According to a note from the bank's traders released last week, historical patterns suggest the decline may be close to concluding.

Historical Context

The momentum strategy, which has outperformed in recent years - particularly in AI and semiconductor stocks - saw significant gains through mid-2024 before the recent pullback. BofA analysts view this as a typical profit-taking event rather than a shift in market dynamics, noting that the underlying companies like Sandisk and Advanced Micro Devices continue to show strong earnings potential. Such mid-year corrections have often been followed by rebounds, supported by favorable seasonal trends.

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Seasonal factors could also provide support. August has historically been the strongest month for this basket over the last decade, BofA traders note. The index currently includes Sandisk Corporation, Micron Technology Incorporated, Danaher Corporation, Coinbase Global Incorporated, and Advanced Micro Devices Incorporated.

The underlying companies, many of which are at the forefront of artificial intelligence and semiconductor development, continue to exhibit strong fundamentals, supporting the case for a rebound.

"Looking through the historical lens - seasonality, the shape of past unwinds, and the asymmetry that follows sharp drawdowns - the weight of evidence leans toward a prolonged profit-taking episode rather than a structural change, with a possible turn approaching," BofA's traders wrote. "Statistically, the current weakness seems to point towards a good near-term entry point."

They pointed to the strength of the underlying companies, many of which are tied to artificial intelligence and semiconductor growth, as a reason to remain optimistic.

Other market participants also detect indications of a trough, at least for the near term. Earlier this week, UBS's trading desk stated that the downturn in momentum stocks could be approaching its conclusion, offering investors a chance to begin re-establishing positions in AI and semiconductor stocks.

BofA's traders suggest that clients purchase the US High Momentum index or the US TMT High Momentum index via swaps or August call options. They noted that past third-quarter pullbacks have typically bottomed near the end of July, with the recovery frequently aligning with the height of earnings season.

"If history rhymes, the bulk of the re-rating typically arrives around month-end," the desk wrote.

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