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Theories explaining momentum typically fall into behavioral, risk-based, or market structure categories, often avoiding the harder question of what economic force actually drives momentum. Yet for U.S. large-cap stocks, data suggest that momentum has closely tracked returns to sales growth over the past eight years. The charts here show cumulative factor returns for 1-year price momentum and sales growth in the S&P 500, using sector-neutral, long-short portfolios rebalanced monthly. The top chart covers the past two years; the bottom spans nearly nine years from July 2016. While there are periods of divergence, the two factors tend to revert toward each other. Based on the data, it's reasonable to view momentum as a proxy for the return to sales growth, augmented by exposure to other short-lived factors. The data are sector-neutral and span all sectors, so the proxy relationship reflects an aggregate pattern that may differ at the sector level. Sales growth's return has trended higher for over a year. Momentum should, in general, follow that directional trend.

Shifts in factor effectiveness signal deeper market narrative changes--specifically, what investors are pricing. The charts here show how ROE, ROIC, and R&D/Sales have influenced Tech stock performance in the S&P 500 over the past three years and the last three months. What do these shifts suggest now? A brief exchange with ChatGPT helped clarify the story. An intriguing idea emerged: 'Tariff Uncertainty and Strategic Autonomy' - see bottom of the transcript. It's an example of AI supporting equity research. I used  Metafoura.com  to uncover these factor shifts. You can explore sector and market-wide factor narratives at  Metafoura.com . Bring your favorite AI. THE TRANSCRIPT Prompt:   I've noticed a shift in tech stock selection factors. From late 2022 to mid-2024, the market was strong. In tech, ROIC outperformed ROE, while R&D/Sales was heavily rewarded. After a sharp drop in July 2024, the market didn't stabilize until September. Since then, R&D/Sales lost its edge, ROE became effective, and ROIC lagged. What explains this shift--especially with AI in the backdrop? ChatGPT: Late 2022 to Summer 2024: The AI-Driven Innovation Boom  AI enthusiasm surged after late 2022, favoring ROIC and R&D/Sales as investors rewarded reinvestment in innovation. ROE lagged, reflecting less concern for near-term shareholder returns or financial leverage. Post-September 2024: A Return to Fundamentals  As the market stabilized, the narrative shifted from "AI moonshots" to execution and monetization. Investors favored firms delivering returns now, not just future growth. Follow-up Prompt:   Over the past three months, ROE and ROIC have lagged, while R&D/Sales has outperformed. Thoughts? ChatGPT: The outperformance of R&D/Sales suggests investors are again prioritizing strategic reinvestment--especially in AI. Likely drivers: 1. AI Capital Spending Surge  - Major tech firms ramped up spending on AI infrastructure--custom chips, data centers, models.  - Short-term ROE and ROIC dipped due to upfront costs, but investors see such spending as a necessary moat.  - R&D/Sales signals innovation and long-term dominance--ROE can't capture forward-looking value. 2. Tariff Uncertainty and Strategic Autonomy  - Rising trade policy concerns (since Feb. 2025) tilt attention toward self-reliance and IP ownership.  - High R&D/Sales firms are better positioned to develop in-house capabilities, reduce supply chain risk, and align with industrial policy shifts.  - Firms optimizing for ROIC or ROE--often outsourcing--may appear fragile in this environment.

Tracking the returns of thematic baskets is a helpful way to see how the tariff turmoil is affecting equities. The chart showing the cumulative excess return of four important themes reveals a potential place to hide and possibly prosper in this environment. The themes are AI, Cybersecurity & Defense, Fintech & Digital Finance, and Industrial Renaissance. Baskets of stocks representing these themes were derived from several ETFs for each theme.  The S&P 500 peak on February 19 was roughly when outperformance in Cybersecurity/Defense and Fintech/Digital Finance peaked this year. AI held on a bit longer, peaking in mid-March (see red arrows). In contrast, the Industrial Renaissance theme bottomed as the Cybersecurity and Fintech/Digital Finance themes peaked.  Industrial Renaissance outperformance has been trending higher since the end of February. That includes stocks such as Union Pacific (UNP), Deere (DE), and others from the Industrials, Non-energy Materials, Utilities, and Energy sectors. Industrial Rennaisance is a goal of the tariffs and looks like a relatively tariff-resilient zone.

Tech stocks are performing poorly in 2025, with February's tariff-driven market shock accelerating the decline. I made a short video examining whether a defining trait of Tech exceptionalism—its ability to monetize innovation—is losing relevance. Take a look.

Value investing's performance has diverged sharply between large-cap and small-cap stocks in recent years. While value strategies have been effective in small caps, they have struggled in large caps. At the same time, investor attitudes toward debt differ: large-cap investors have benefited from highly leveraged companies, while small-cap investors have not. This contrast is evident in charts tracking cumulative returns over the past three years for long-short, sector-neutral, monthly-rebalanced portfolios sorted by free cash flow (FCF) yield, Sales/Price, Earnings/Price, and Debt/Equity in the S&P 500 and Russell 2000. A bracket highlights the three value factors in each chart. Why Is This Happening? Small-cap companies typically carry more relative debt than large caps. As shown in the chart, FCF yield has delivered strong returns for Russell 2000 stocks—27% per year over the past three years and 32% in the last year. Small-cap investors likely prioritize FCF yield because it mitigates debt risk. Strong sales and earnings also reinforce financial stability. Highly leveraged small caps are less attractive. Conversely, investors have been rewarded in large caps for favoring high debt-to-equity companies. This strategy has worked (so far) because large firms generally have stronger cash flows and financial stability, cushioning the risks of high leverage. Given this dynamic, it is unsurprising that FCF yield has not been a priority for large-cap investors. In short, leverage and value investing have played distinct roles in large-cap and small-cap stocks.

AI-based techniques, such as natural language processing (NLP) analysis of earnings calls, can reveal management or analyst sentiment about a company, potentially helping to predict market behavior. But what about investors' sentiment? Factor trends—the patterns of which factors generate returns and which factors are dismissed by the market—provide insights into investors' sentiment based on their factor narrative.

Is money better spent on research to drive innovation in small or large companies? This question is significant for government policies promoting innovation and investors seeking factors that provide an advantage. The prevailing belief is that innovation occurs more often in small companies than in large ones. Since innovation relies on funding, smaller companies should yield greater rewards from research expenditures. However, the charts here show that, on average, research spending has produced significantly better investment returns in large companies.

Typically, earnings growth is more important than sales growth for stock performance. However, as the chart illustrates, this was not the case in 2024. When the market rebounded in early August after the decline in July, sales growth became more significant than earnings growth for stocks in the S&P 500. Since the beginning of August, the long-short factor return for sales growth of S&P 500 stocks, measured as sector-neutral, has increased by 10%, better than the return from momentum, which rose by 8.5%. In contrast, the earnings growth factor return has declined by 3% since the beginning of August.

Since early September, small-cap stocks have outperformed large-cap stocks. Investors' recent enthusiasm for small caps is evident in their positive view of high capital spending. The chart's red line highlights a consistent positive return for being long stocks with high Capex-to-Assets ratios and short stocks with low ratios during this period, namely a consistently positive Capex-to-Assets factor return since early September. The small-cap rally reflects an assumption that the risks associated with high capital spending are worth taking--a risky bet.

The stock market reacted enthusiastically to the election results, and momentum played a significant role in almost every market segment.

It is surprising and potentially alarming that financial leverage has been a powerful driver of stock returns during the market rally over the past year. For stocks in the S&P 500, the sector-neutral long-short factor return for debt/equity was 12% since October 31, 2023, with an impressive 2.7 information ratio. In contrast, the ROE and price momentum factors returned 7.7% over this period, with a 1.3 information ratio for ROE and a 0.6 information ratio for momentum.

In a recent post, I highlighted an example of what can be missed when using a passive index approach to value. In the consumer staples sector of the S&P500, the long-short returns for Earnings/Price and Sales/Price have diverged massively since the end of March. The divergence happens because of industry effects within the sector. The Earnings/Price strategy is long food and tobacco production, while short food and staples retail. At the same time, the Sales/Price strategy is long food and staples retail, while short household products and food and tobacco production.