Momentum investing, a strategy that capitalizes on the continuation of existing market trends, faced significant headwinds in 2023 and more recently in 2025. The momentum factor, which performed exceptionally well in prior years, saw one of its worst months in January 2023—the most challenging period since April 2009. This sudden downturn led some investors to question the validity of momentum investing, while skeptics resurfaced with their critiques.

However, seasoned investors understand that factor investing, including momentum, is cyclical. Just as other investment factors have periods of underperformance, momentum is not immune to short-term setbacks. And when momentum loses momentum, can quality become the winning trade? Let’s look at this in detail today.

Why has momentum investing worked?

Momentum investing is a style factor strategy that involves increasing exposure to stocks that have demonstrated strong recent performance and reducing exposure to underperforming stocks. The premise is that stocks that have performed well in the past tend to continue performing well in the near future. It has proven to be a persistent and historically rewarded factor. Factors guiding momentum investing have strong economic rationales, empirical backing for positive expected returns, and diversification benefits when combined with other style factors.

The persistence of momentum can be explained through behavioral finance. Investors’ biases, such as herding behavior and gradual adjustment to new information, contribute to momentum trends in the market. Additionally, the risk-based explanation suggests that momentum investors are compensated for bearing the risk of short-term volatility and potential market downturns.

While momentum can experience periodic short-term crashes (as seen in 2001, 2009, 2023 and more recently in 2025), long-term data suggests that the strategy offers a significant premium, rewarding investors willing to endure short-term fluctuations.

Key Takeaways of Momentum Investing:

1. Focus on Upward-Trending Stocks – Momentum strategies prioritize stocks with strong recent price performance, typically over a 3 to 12-month period.

2. Well-Established Strategy – Momentum investing has been around for decades and is backed by both economic theory and empirical data.

3. Complementary to Other Strategies – Momentum investing can be effectively combined with other style factor strategies like quality, value, and size.

Factors Are Cyclical

Factor investing is inherently cyclical. Investors who recognize this accept that periods of underperformance are not a sign of failure but rather an integral part of the investment cycle. Factors such as value, size, and quality have all experienced phases of diminished returns before rebounding, and momentum is no exception.

For investors willing to endure these cycles, momentum portfolios offer a way to maintain exposure to the long-term momentum premium. These funds enable investors to capture potential future gains once the factor regains strength.

When Momentum Falters, Quality Can Shine

While momentum investing has historically delivered strong returns, it is prone to sharp reversals, as seen in early 2023. When these reversals occur, investors often seek alternative strategies that offer resilience and stability. One such approach is quality investing, which prioritizes companies with strong financials, consistent earnings, and durable business models.

Quality stocks tend to exhibit lower volatility and better risk-adjusted returns during periods of market stress. Unlike momentum, which thrives on price trends, quality investing focuses on companies with high return on equity (ROE), low debt levels, and strong profit margins. It also focuses on purchasing financially healthy companies with strong earnings, stable balance sheets, and efficient capital utilization. These characteristics can provide a cushion during downturns, making quality an attractive strategy when momentum loses steam.

Trade War Parallels: Quality’s Resilience Over Momentum

The 2018-2019 Trade War

A prime example of this was observed during the last major trade war in 2018-2019, when U.S.-China tensions disrupted global markets. During this period, momentum stocks, which had been thriving on bullish market trends, suffered sharp corrections as trade uncertainties escalated. Meanwhile, quality stocks, characterized by strong fundamentals and stable cash flows, demonstrated resilience. Companies with solid earnings and sound financials managed to navigate the turbulence more effectively, providing investors with a buffer against extreme market swings. This period reinforced the notion that while momentum investing can be lucrative in bullish phases, quality investing serves as a defensive anchor during uncertain economic and geopolitical times.

The Current Trade War and Its Market Impact

Today, with ongoing geopolitical tensions and rising trade barriers affecting multiple economies, investors are witnessing a similar pattern. Just as in 2018-2019, momentum-driven stocks have been more volatile, reacting sharply to tariffs, sanctions, and supply chain disruptions. In contrast, quality stocks have once again displayed resilience, supported by their strong balance sheets and fundamental stability. Investors looking for a factor-based approach that balances growth with defensiveness may find quality investing to be an appealing choice during this period of economic uncertainty.

Why Quality Investing?

To understand quality investing, consider a simple analogy: imagine you are at a grocery store choosing between organic and non-organic apples priced the same. Given this choice, most would opt for organic apples, recognizing their higher quality. Similarly, quality investors seek to get the most value for their investment by selecting superior companies without necessarily paying a premium price.

Quality investing has a strong economic basis for its success. Research and empirical data indicate that quality stocks tend to outperform lower-quality stocks over the long run. This strategy offers a reliable approach to achieving strong and stable returns, making it a popular factor investing method.

Key Characteristics of Quality Investing:

1. Strong Earnings and Stable Finances – Quality investors seek companies with a history of reliable earnings growth and strong financial health.

2. Proven Historical Success – Quality investing is not a new concept; it has been supported by decades of economic theory and real-world market data.

3. Quantifiable Metrics – Quality strategies evaluate companies based on measurable factors such as return on equity (ROE), low debt levels, and consistent earnings.

Case for Quality Investing

Empirical research suggests that quality stocks not only hold up better in bear markets but also deliver competitive long-term returns. In contrast to momentum, which is driven by investor behavior and sentiment, quality investing is anchored in fundamentals. High-quality companies tend to outperform in turbulent environments because they possess strong competitive advantages, stable earnings, and the ability to generate cash flow even in challenging economic conditions.

Furthermore, quality investing can serve as a complementary factor to momentum. While momentum tends to do well in strong bull markets, quality can provide stability during uncertain times. Investors who blend these factors strategically may achieve a more balanced portfolio, mitigating the extreme swings associated with momentum crashes.

As momentum investing faces renewed scrutiny, quality stocks could emerge as the next winning trade. Their ability to generate steady returns and withstand market volatility makes them a compelling alternative for investors seeking a factor-driven approach with resilience.