Why the stock-market's red-hot momentum trade might be headed for a violent unwind this month

By Christine Idzelis

Momentum trades tend to struggle in July - but this year may be particularly volatile, says one strategist. The rumblings have already started.

The U.S. stock market may see explosive moves beneath the S&P 500 index's surface in July.

U.S. stocks are set up for potentially dramatic rotations beneath the S&P 500 index's surface, with rumblings already underway following a stratospheric rise in semiconductors shares.

An astounding rally in momentum stocks, captured by the performance of the Invesco S&P 500 Momentum ETF SPMO, just helped drive major indexes like the S&P 500 SPX and Nasdaq Composite COMP to their biggest quarterly gain in six years, according to Dow Jones Market Data.

Investors piled into shares of companies benefiting from the massive spending of the so-called hyperscalers - the Big Tech giants plowing hundreds of billions of dollars into building artificial-intelligence data centers across the U.S.

Shares of the Invesco S&P 500 Momentum ETF - which trades under the ticker symbol "SPMO" and holds about 100 stocks with the highest momentum scores in the S&P 500 - skyrocketed about 44% in the three months through June, marking its strongest quarterly performance since it began trading in 2015, FactSet data show.

But the momentum trade has hit the skids during the first two trading sessions of July, with the ETF down 6.6% this month through Thursday. Highflying semiconductor stocks have been hit particularly hard; the Invesco PHLX Semiconductor ETF SOXQ, which tracks U.S.-listed stocks in the industry, has dropped 11.4% so far in July.

A historical analysis of how momentum stocks typically perform in July suggests that there could be more fireworks ahead.

While July is typically a good month for U.S. equities overall, investors could see a "violent rotation" away from the momentum factor during the coming weeks if the recent past is any guide, said Warren Pies, co-founder and strategist at 3Fourteen Research, in a phone interview.

According to Pies's analysis, momentum stocks have sold off during the past five Julys.

"My view is that this is going to be an especially volatile July" for the momentum trade, Pies said.

The heat map below highlights monthly returns of the momentum factor - calculated as the top 10% of stocks with momentum in the S&P 500 divided by the bottom 10% - over the past five years, according to 3Fourteen Research. July stands out for seasonal weakness for momentum, with the map showing an average five-year return of about negative 5% for the month.

3Fourteen Research

One popular trade during the first half of 2026 involved investors buying semiconductor stocks and selling shares of hyperscalers, a group that includes Microsoft (MSFT) and Facebook parent Meta Platforms (META), according to Pies. But this trade has recently started to lurch into reverse.

The shift could be hard to spot at the index level, particularly if investors rotate out of semiconductors and back into shares of the hyperscalers, Pies said. The hyperscalers are still among the most valuable companies in the world despite their recent struggles, and their strength could help offset losses from the semiconductor cohort. Recently, shares of the hyperscalers have been rising on days when semiconductor stocks have fallen.

To some degree, the AI race is laced with inflation concerns for the stock market in the near term, as strong demand for chips has led to pricing power for companies that make them.

The AI buildout has prompted a tremendous expansion in capital expenditures as a percentage of gross domestic product that is reminiscent of the 19th-century buildout of the railroad system in the U.S., said Michael Rosen, chief investment officer of Angeles Investments, in an interview.

Such heavy demand for AI-related infrastructure has led to supply pressures that have pushed up prices in some parts of the economy, as investors closely monitor U.S. inflation that's already been stuck above the Federal Reserve's 2% target.

While many investors expect that, over the long term, AI could bring about a disinflationary productivity boom in the labor market, strong demand for AI in the meantime has created bottlenecks in the supply of memory chips needed for the revolutionary technology.

That's been a boon to earnings for memory-chip companies like Micron Technology. Although shares of Micron (MU) have plunged 15.5% so far in July, the stock remained up almost 242% this year through Thursday, according to FactSet data.

Vanguard expects the AI complex will generate more than half of all U.S. earnings growth within the S&P 500 this year and next. That could lead to concentration risk, said Qian Wang, the asset manager's global head of capital-market research, in an interview. The AI buildout can still be a "powerful trade," she said, but it's also fragile due to the concentration of 30 to 40 AI stocks in the S&P 500 coupled with investors' high expectations for earnings growth, she said.

Doubts about their profitability could introduce a lot of volatility to the AI trade, so while investors should participate in it, they should also "be prepared for a very bumpy ride," Wang noted.

As many U.S. investors have portfolios heavy in growth equities and with a "home bias," they may consider diversifying into value stocks or international developed markets, such as Japan and Europe, for exposure to AI as more companies adopt it over the longer term, according to Wang.

That might mean investing incrementally in such pockets of the equities market with "your next dollar," as opposed to selling or rotating portfolios aggressively to buy shares, she said.

Pies expects that investors taking profits from the run-up in chips stocks may find opportunities this month in oversold equities tied to the "quality factor" - particularly those in the relatively "disjointed" pocket of beaten-down stocks with momentum scores in the bottom 10% of the S&P 500.

"Quality has become synonymous with potential AI disruption," he said - explaining that AI is generally viewed as having the potential power to destroy the competitive "business moat" associated with quality companies.

Dispersion

Dispersion in the U.S. stock market has been high, which generally reflects a bull market, according to Pies.

"It's a highly rotational market," he said. That means that rather than seeing a potential correction at the index level as certain stocks sell off, the S&P 500 may appear flat or "choppy" on the back of "dramatic moves" under its hood in this type environment.

Stock-market rotations, however violent they may turn out to be in July, can help keep everything in the market from moving together at once, said Pies, adding that may be a "recipe for new highs later this summer."

One gauge is pointing to low stock-market correlations, with the Cboe 1-Month Implied Correlation Index approaching levels last seen two years ago.

"Internal correlations drop as a bull market ages," according to Pies. So "once you have really low correlations, some people might start looking for a top signal," he said - although for now, "I think that's a little premature," he added.

But he cautioned that "fragility comes back if correlations start to get closer to the norm."

The Dow Jones Industrial Average DJIA ended sharply higher Thursday in a holiday-shortened week that saw the market closed for trading on Friday in observance of the Fourth of July. The July 4 holiday fell on a Saturday, with the U.S. celebrating its 250th birthday.

The S&P 500 edged up less than 0.1% Thursday to close nearly flat, while the technology-heavy Nasdaq Composite dropped 0.8%, with both benchmarks booking weekly gains alongside the Dow.

There are already signs of a rotation trade shaping up since the start of July. The Invesco S&P 500 Equal Weight ETF RSP, which tracks an equal-weighted version of the S&P 500 XX:SP500EW, is outperforming its capitalization-weighted sibling so far this month, FactSet data showed.

The selloff in semiconductor names has weighed on the information-technology sector XX:SP500.45, the largest group in the S&P 500. The tech sector has posted a big loss to start the month.

"From my perspective, the fundamentals for this bull market remain resilient," said Michael Arone, chief investment strategist at State Street Investment Management, in a phone interview. "The rotation is healthy," he noted, and it appears "investors are reluctant to leave equities - they're just changing where they're investing."

-Christine Idzelis

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