Market commentary equities: Has momentum broken down?

Third quarter 2026: European equity update

The third quarter has brought a noticeable change in the European equity market environment. Momentum – one of the market’s strongest and most persistent performance drivers – has weakened sharply in selected areas. This has naturally raised an important question for investors: if a strategy performed strongly while momentum, e.g. the recent price trend of stocks, was supportive, should we expect those gains to reverse now that the factor has broken down?

The concern is understandable. Our analysis confirms that our European equity strategy’s relative performance in the past 5 years has been stronger when the momentum factor was in a positive trend. However, the results also show that a momentum correction alone is not sufficient to conclude that the investment process has stopped working. What matters more is whether the correction remains isolated or develops into a broader period of unstable and rapidly changing factor leadership.

Volatility and factor rotation are not the same

In assessing the market environment, we distinguish between two related but different concepts.

Factor volatility measures the magnitude of movements in factors such as momentum, value, quality and market capitalisation. A factor can experience large price movements while maintaining the same underlying direction, that means an increase in volatility is not automatically associated with a trend break.

Factor rotation measures how frequently those trends change direction. A market in which momentum weakens while value strengthens – and both trends then reverse again shortly afterwards – is more difficult for an active equity strategy than a market characterised by one large but persistent adjustment.

To capture this distinction in the current environment, we created a standardised trend indicator for each of the four factors – value, quality, momentum and size. It compares the respective factor’s cumulative 13-week active return with the volatility normally associated with that period.

A factor is considered to have a confirmed positive trend when its indicator rises above +0.5 volatility units and a confirmed negative trend when it falls below −0.5. Movements within the neutral range are not treated as genuine trend changes. This helps prevent normal market noise from being classified as a new regime.

A reversal is counted only when a factor moves from a confirmed positive trend to a confirmed negative trend, or vice versa.

What the Q3 environment is telling us

At the latest point covered by our analysis, the four factors had recorded three confirmed reversals over the preceding 13 weeks. We classify this as a moderate-rotation environment.

Our broad classification is:

• Zero to two reversals: relatively stable factor environment
• Three reversals: moderate rotation and declining trend stability
• Four or more reversals: high rotation
• Six or more reversals: exceptionally unstable or extreme rotation

The current signal therefore suggests that market leadership has become less stable, but it has not yet reached a high-rotation regime.

This does not mean that three different factors necessarily reversed. One factor can change direction more than once and contribute multiple reversals. The measure simply counts the total number of confirmed changes across momentum, value, quality and size during the rolling period.

The recent momentum breakdown nevertheless deserves close attention. Momentum has been associated with better relative returns for equity strategies in general, and its deterioration removes a previous tailwind. The immediate outlook for investors that utilise momentum in their investment process is consequently less favourable than it was during a stable, positive momentum regime.

The key question for the remainder of 2026 is whether the weakness remains concentrated in momentum or spreads to other factors. If value, quality or size begin to reverse repeatedly, the total reversal count could move into the high-rotation range. That would represent a more meaningful deterioration in the environment for relative performance of systematic strategies.

What history suggests about relative performance

Quoniam’s European equity strategy generated its strongest relative returns when factor trends were stable. Performance was broadly neutral when the reversal count reached the moderate rotation regime and slightly negative when there was a high rotation regime.

Over the full period analysed, the strategy delivered an annualised active return of 4.77%, a tracking error of 4.74% and an information ratio of 1.01. It outperformed in approximately 56% of individual weeks. These results indicate that the longer-term relative performance was meaningful and was not dependent on winning every week.

At the same time, the analysis shows that expectations should be moderated when factor leadership becomes unstable. In a moderate- or high-rotation environment, it would be prudent to expect a less consistent path of relative returns, including a greater likelihood of periods of underperformance.

Does the momentum breakdown invalidate the process?

Our conclusion is no – but it changes the balance of risks.

The historical association between positive momentum and stronger active returns should not be ignored. Yet association is not the same as causation. The analysis does not demonstrate that the strategy’s gains were produced exclusively by momentum exposure, nor does it establish that a momentum reversal must lead to a reversal of year-to-date outperformance.

An isolated momentum breakdown represents one confirmed change in the factor environment. It becomes a more serious warning signal when accompanied by repeated reversals in momentum itself or by simultaneous changes in several other factors.

This distinction is important. A sharp but durable transition from one group of market leaders to another can create opportunities for fundamental stock selection once the new direction becomes established. A market in which leadership repeatedly changes, by contrast, offers fewer persistent signals and can punish positions before their underlying investment cases have time to develop.

Therefore, the challenge is therefore not just that momentum has fallen. Rather, the question is whether the wider market is entering a sustained period of factor instability.

Implications for the remainder of the year

The Q3 evidence argues for vigilance rather than a binary conclusion.

The present environment is less supportive than the stable factor regime in which the strategy generated its strongest relative returns. Momentum weakness is a legitimate headwind, and the move to three reversals suggests that market leadership is becoming less dependable.

However, the available evidence does not yet indicate a full breakdown across factors. A move to four or more reversals over 13 weeks would provide a stronger warning that the market had entered a high-rotation regime. Until then, the current conditions are better described as transitional rather than extreme.

The following three developments are therefore interesting to monitor:

• Whether momentum establishes a persistent negative trend or begins to stabilise
• Whether the weakness spreads to value, quality or market capitalisation
• Whether the overall 13-week reversal count rises from moderate to high

The factor indicators are not short-term trading signals. Their one-week-ahead relationship with relative returns was weak. Their value lies in describing the environment, setting realistic expectations and identifying when the conditions for active systematic performance have become more or less favourable.

Conclusion

The momentum breakdown has reduced an important historical tailwind for systematic strategies and warrants a more cautious near-term assessment. Investors should be prepared for relative performance to become more volatile than it was during the earlier, more stable phase of the market.

At the same time, one factor reversal should not be confused with the failure of a systematic investment process. Our analysis suggests that broad and repeated factor rotation – not momentum weakness in isolation – has been the more important indicator to monitor.

The positive year-to-date relative performance of systematic strategies is therefore not automatically expected to reverse. The risk of such a reversal would increase if momentum weakness were to spread across the factor landscape, pushing the reversal count into the high-rotation range.

For now, the evidence points merely to a changing and more demanding environment, but not an extreme one.