Will Momentum Investing Work in 2025?

Over the past few years, momentum investing has gained traction as markets worldwide have experienced significant rallies, driven by post-pandemic recoveries, accommodative monetary policies, and technological disruptions. Mutual funds in the momentum category have consistently attracted investor attention due to their ability to outperform benchmarks during bullish phases.

Historically, momentum mutual funds have delivered robust returns during bullish market cycles. In India, for instance, these funds performed exceptionally well during the market uptrend of 2021 and 2022, fueled by the rise in technology stocks, rising consumer demand, and abundant liquidity in the system.

[Read: All You Need to Know About Momentum Mutual Funds]

However, momentum investing isn't without challenges. It often struggles during market downturns or periods of heightened volatility, where trends may reverse abruptly, negatively impacting fund performance.

In 2023 and 2024, as global uncertainties like inflationary pressures, geopolitical tensions, and fluctuating economic recoveries came into play, momentum mutual funds faced mixed fortunes. While the strategy worked well for sectors like IT and clean energy, it faltered in others due to market volatility and sectoral rotations.

However, as we move into 2025, there are growing concerns about the efficacy of this strategy, especially with the unpredictable shifts in the global economy, the Indian equity market's current situation, and various macroeconomic and geopolitical risks. Investors are questioning whether momentum investing could continue delivering handsome returns or if it's time to pivot towards more stable strategies like large-cap or value investing.

In this article, we will explore why 2025 might not be a great year for momentum investing, the risks involved, and why large-cap funds could be a better alternative for investors seeking stability and lower risk in the coming year.

Navigating Market Volatility in the Trump 2.0 Era

The global markets are still reeling from the aftermath of the 2020 pandemic and the changing political landscape. The election of Donald Trump to a potential second term, Trump 2.0, will inevitably impact global trade policies, geopolitical tensions, and domestic market regulations. While Trump's first term was marked by significant tax cuts, deregulation, and a focus on 'America First' policies, a second term could trigger further volatility.

If Trump indeed returns to office, his policies could amplify global uncertainty, particularly for markets like India that are closely tied to U.S. policies. For example, a re-escalation of the trade war between the U.S. and China, potential policy shifts around supply chains, or tariffs could hurt growth prospects for emerging economies, including India. Such developments would directly impact Indian equities, causing market volatility and undermining the effectiveness of momentum investing strategies.

[Read: How Donald Trump's Victory Would Playout On the Indian Equity Market]

Moreover, Trump's unpredictability and the polarised political environment in the U.S. could add layers of unpredictability that make it challenging for investors to anticipate trends. In such an environment, the smooth upward trajectory that momentum investing depends on may face substantial resistance, making it a risky strategy for 2025.

Mastering Market Fear: Utilising the VIX Indicator

One of the most important indicators of market sentiment is the Volatility Index (VIX), often referred to as the 'fear gauge.' The VIX measures the market's expectations of volatility and is closely tied to investor sentiment. When the VIX spikes, it generally signals heightened uncertainty and risk, often linked to broader market sell-offs or geopolitical crises.

A higher VIX indicates heightened anxiety and anticipated market fluctuations, while a lower VIX suggests a calmer market outlook. The graph reveals a dynamic picture of India's market volatility over the past few years, with periods of elevated fear interspersed with phases of relative calm, where the VIX remains at lower levels.

These fluctuations likely reflect a combination of factors, including global economic events, geopolitical developments, domestic policy changes, and investor behaviour. Analysing these trends could provide valuable insights into market sentiment and inform investment strategies.

As we approach 2025, volatility in global markets is expected to remain high, particularly in light of the political uncertainties surrounding Trump 2.0 and other macroeconomic factors. For instance, if the US Federal Reserve continues to raise interest rates to tackle inflation or if there are other financial disruptions, the VIX could spike significantly, indicating rising market fear.

An increase in the VIX would likely make momentum investing less effective in 2025. Momentum-based strategies thrive on stable trends, where prices rise or fall consistently over time. When volatility increases, however, market movements become erratic, making it difficult for momentum strategies to keep up with the market.

Indian Equity Markets: Losing Upside Momentum

Indian equity markets have been among the best performers in emerging markets in recent years, driven by strong domestic growth, government reforms, and global liquidity. However, signs of slowing momentum are beginning to emerge.

Firstly, India's GDP growth rate has been steadily decelerating, with the country facing inflationary pressures and challenges related to unemployment. In addition, global headwinds such as commodity price inflation, rising interest rates, and disruptions in the global supply chain have weighed heavily on India's economic outlook.

[Read: The Key Factors Behind the Recent Volatility in the Indian Equity Market]

Furthermore, Indian equities are facing a loss of upside momentum as valuations are becoming stretched. The Nifty 50 and S&P BSE Sensex, which are key indices representing the Indian stock market, have seen significant growth in recent years. However, at current valuations, the market appears to be in a consolidation phase, and further significant upside may be limited.

This lack of strong momentum in Indian equities makes it harder for momentum investing strategies to work effectively. If the market is range-bound or if stock prices start to plateau, momentum stocks will struggle to continue their outperformance, leaving investors vulnerable to market swings.

The combination of slowing economic growth, political uncertainties, and rising global risks points to an increased likelihood of turbulence in Indian equities in 2025. Rising inflation and the tightening of interest rates globally could slow down domestic consumption and impact corporate earnings growth.

Additionally, India's external vulnerabilities, such as dependence on oil imports and foreign capital inflows, make it susceptible to global disruptions. With the U.S. dollar potentially strengthening due to higher interest rates in the U.S., emerging markets like India could experience capital outflows, which would further dampen investor sentiment.

While the Indian stock market has enjoyed a favourable macroeconomic environment in recent years, the backdrop for 2025 looks increasingly uncertain. In such an environment, investors may find that momentum strategies, which depend on stable market trends, are unlikely to deliver the same results as they did in previous years.

Equity Market Returns: Expectations for 2025

Given the heightened volatility and macroeconomic fluctuations impacting market performance, equity returns in 2025 are expected to be limited. The period of robust equity growth driven by post-pandemic recovery may be over, and investors may face more muted returns in the coming year.

Analysts predict that returns from equities in 2025 may be lower than historical averages. With the Indian market entering a phase of consolidation and increased global uncertainty, it's likely that stock prices will move sideways or experience short-term corrections rather than seeing strong, consistent upward trends.

For momentum investors, this is a significant challenge. The basis of momentum investing is that strong-performing stocks will continue to perform well, but in a market characterised by limited upside, this may not be the case. Instead of seeing sustained growth in high-flying sectors, investors may encounter increased volatility and corrections, which may lead to significant losses in momentum-based strategies.

Momentum mutual funds, which invest in stocks that are currently trending upward, are built around the idea of riding trends to capture gains. However, with the risk in play from heightened global volatility to a slowing Indian economy, it would be imprudent to expect these funds to continue delivering handsome returns in 2025.

The performance of momentum mutual funds is closely tied to the direction of market trends. If the market faces headwinds or sectors or stocks lose momentum due to macroeconomic factors, these funds could see sharp declines in value. The lack of sustained trends could affect the ability of these funds to generate alpha, making them a riskier option for investors in 2025.

In such a turbulent environment, it would be more prudent for investors to consider large-cap funds over momentum-based strategies.

Why It Is Better to Choose Large-Cap Funds Now

Large-cap funds tend to invest in established, well-capitalised companies that are less likely to experience wild fluctuations during periods of market volatility. These companies often have robust financials, strong competitive advantages, and are better equipped to weather economic slowdowns.

Large-cap funds are also more likely to generate steady returns, even in uncertain market conditions. While they may not offer the explosive growth that momentum funds promise, they provide stability and a more reliable path for investors who are looking to preserve capital during times of market turbulence.

[Read: Why You Should Choose Large-Cap Funds Over Mid-Cap and Small-Cap Funds Now]

In 2025, the focus should shift from chasing short-term gains through high-risk momentum investing to building a more resilient portfolio with large-cap exposure. By investing in large-cap funds, investors could ensure that their investments are tied to companies with established market positions, solid financials, and a history of navigating through economic downturns.

Final thoughts...

Momentum investing, which has been an attractive strategy in recent years, may encounter significant challenges in 2025. With rising volatility, the potential for heightened political risk, and slowing economic growth, the market environment is expected to be more turbulent than in the past. As a result, investors looking for steady returns and lower risk in the coming year should consider alternatives to momentum mutual funds.

Large-cap funds, with their focus on stable, established companies, present a more prudent choice for investors in 2025. These funds offer greater protection against market volatility and provide steady long-term growth potential. In a year where returns from equities may be limited and risks are higher, large-cap funds offer the best opportunity for investors seeking to preserve capital while navigating the turbulence ahead.

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MITALI DHOKE is a Research Analyst at PersonalFN. She is an MBA (Finance) and a post-graduate in commerce (M. Com). She focuses primarily on covering articles around mutual funds including NFOs, financial planning and fixed-income products. Mitali holds an overall experience of 4 years in the financial services industry.
She also actively contributes towards content creation for PersonalFN’s social media platforms in the endeavour to educate investors and enhance their financial knowledge.
 

Disclaimer: Investment in securities market are subject to market risks, read all the related documents carefully before investing.
This article is for information purposes only and is not meant to influence your investment decisions. It should not be treated as a mutual fund recommendation or advice to make an investment decision in the above-mentioned schemes.