Market darling to drawdown: Why momentum stocks are losing steam

The momentum factor, which champions buying recent winners, is currently navigating its fourth-deepest drawdown in 21 years, signaling a profound challenge for a strategy that has long been a market darling. However, defying this longer-term pain, May 2026 witnessed a stunning reversal, with momentum stocks, particularly those tied to the booming Artificial Intelligence sector, staging a powerful rally that has reignited debates over its enduring relevance. This whipsaw performance underscores a critical crossroads for investors, caught between historical underperformance and a potent, tech-driven resurgence. The broader market's shift towards hawkish monetary policy by the Federal Reserve, coupled with persistent inflation concerns and increased geopolitical uncertainty, initially fueled the factor's decline as capital rotated into value and defensive plays. Quantitative strategies, heavily exposed to these trends, faced significant pressure from crowded positioning and rapid reversals, exacerbating the drawdown. Yet, the narrative has swiftly pivoted; massive capital expenditures in AI infrastructure, with analysts projecting hyperscaler spending to soar to $754 billion in 2026, have provided an undeniable tailwind, concentrating earnings power and driving significant gains in tech-heavy momentum portfolios. Looking ahead, the sustainability of this AI-fueled momentum surge remains the central question, testing investor patience amidst fluctuating macroeconomic signals. While some anticipate a multi-year run akin to the Dot Com era, others warn that continued hawkishness from central banks or an escalation in geopolitical tensions could quickly deflate the rally, re-exposing momentum strategies to significant market volatility. Market participants will closely monitor upcoming inflation data, Fed commentary, and the earnings dispersion across sectors to gauge whether this recent resurgence marks a genuine turning point or merely a temporary reprieve within a prolonged period of challenge.