The Chameleon Factor: Understanding the Recent Momentum Unwind and Its Implications for the Market and Bitcoin

Momentum investing is often considered one of the most persistent factors in financial markets, but its nature is highly adaptive. In my YouTube videos since mid December, I have highlighted the ever-growing warning signs in momentum. Over the past six days, markets have witnessed a sharp unwind in momentum trades, a phenomenon that often signals a shift in underlying market dynamics or a regime shift. As legendary trader Jesse Livermore, one of the most famous stock speculators of the early 20th century and a pioneer of momentum-based trading, famously said, “Successful traders always follow the line of least resistance. Follow the trend. The trend is your friend until the end when it bends.” Momentum, unlike other factors, is a "chameleon" in the investment landscape—it morphs based on the dominant thematic drivers. As a famous line says, "Momentum is the ultimate trend follower—it thrives on strength but suffers from hesitation." Whether driven by macroeconomic forces, innovation cycles like artificial intelligence (AI), or fundamental earnings trends, momentum flows aggressively into prevailing market narratives until those narratives shift, causing sharp reversals.

This adaptability is what makes momentum such a powerful yet volatile force. It can seamlessly transition between asset classes and themes, chasing growth in sectors fueled by innovation one moment and macro-driven reflation trades the next. This line sums this up well, "Momentum doesn’t have a style—it has an identity crisis. Today’s growth darling can be tomorrow’s value trap." The most recent momentum unwind follows a period of AI-driven euphoria, where companies benefiting from cloud computing, semiconductors, power needs, cyber, data analytics, quantum and overall hyperscaler driven spending saw sustained inflows. This came as investor expectations were for accelerating growth from the new administration with continued inflation declines and Fed cuts. DeepSeek and tariff announcements hurt psychology in these trends and in the last six days, the trend was no longer a friend and it bent.

Momentum Unwinds at Macro Inflection Points

Historically, momentum unwinds tend to occur at macroeconomic inflection points, where shifts in liquidity, interest rate expectations, or geopolitical events disrupt the prevailing trend. For example, in late 2021, the Federal Reserve’s pivot away from “transitory” and toward tighter monetary policy triggered a broad rotation away from high-growth technology stocks, abruptly ending a long-standing momentum trade. Similarly, during the COVID-19 market recovery in 2020, momentum initially favored work-from-home beneficiaries but swiftly rotated into reopening trades as vaccines were announced. In late 2022, the Federal Reserve pivoted once again, sparking optimism about the end of the rate hike cycle. However, this enthusiasm was short-lived as the collapse of Silicon Valley Bank in March 2023 abruptly reignited recession fears, driven by the Fed's aggressive rate increases.

These transitions tend to leave a vacuum in the market. After a significant unwind, momentum does not immediately find a new anchor—it often takes time for the next dominant narrative to emerge. This pattern underscores the cyclical nature of momentum: it moves in waves, adjusting to shifting macro forces but requiring a period of consolidation before its next resurgence. The current unwind suggests that the market is reassessing the composition of AI-driven momentum. AI is accelerating at lightspeed and despite a macro regime narrative shift, a recession or significant rise in inflation is unlikely to me so I think AI will again likely be a major part of the next momentum trade. As I have said in my videos and prior posts, I believe AI agents will be a major driver this year which would be about productivity. Instead of concentrated gains in a few infrastructure names, the next leg of AI momentum would be more distributed, focusing on real-world productivity improvements across industries.

The Psychology Behind Momentum

Momentum investing is not just a product of market mechanics—it is deeply tied to investor psychology and behavioral biases. The human tendency to chase what is already working is driven by a mix of herd mentality, recency bias, and fear of missing out (FOMO). Investors often anchor to recent winners, assuming trends will persist indefinitely, which reinforces the strength of momentum trades. Dopamine-fueled trading behavior amplifies the cycle, as rising prices trigger further buying, creating self-reinforcing trends—until they abruptly reverse. Behavioral finance has long recognized that momentum investing thrives on emotion as much as fundamentals, making it one of the most powerful yet unstable market forces. This explains why momentum unwinds tend to be sharp and chaotic: as soon as enough investors begin doubting the trade, psychology shifts from greed to fear, leading to rapid liquidation. Recognizing the behavioral drivers behind momentum can help investors navigate these cycles with greater awareness.

AI Momentum: From Infrastructure to Productivity

If AI-driven momentum is shifting, we may be witnessing the early stages of a new market leadership structure. The initial phase of AI enthusiasm was built on "picks and shovels" plays—companies providing the infrastructure, such as Nvidia, cloud hyperscalers, power suppliers, cybersecurity firms, and data centers. These stocks benefited from a gold rush mentality, where investors sought exposure to the foundational layers of AI development, further fueled by speculative enthusiasm and investor psychology.

However, as AI adoption moves from theoretical potential to real-world productivity gains, market momentum may shift toward companies that effectively implement AI to enhance efficiency, automation, and profitability. Walmart’s recent embrace of AI-driven inventory management and logistics optimization is an early signal of this transformation. If this transition materializes, the next winners will not be infrastructure providers but companies leveraging AI to drive earnings growth through adoption and efficiency gains, creating a more idiosyncratic and less sector-concentrated momentum trade.

Bitcoin: The Chameleon of Chameleons

While momentum is inherently adaptive, Bitcoin stands out as an even more enigmatic case—a chameleon of chameleons. Unlike traditional assets, Bitcoin lacks a fundamental valuation anchor, meaning its momentum-driven cycles are often dictated by liquidity conditions and broader risk appetite. Bitcoin performs best when markets are in a risk-on mode, and liquidity is ample. In bull markets, it trades like a high-beta tech stock, benefiting from speculative inflows, while in bear markets, it can behave like a liquidity-sensitive asset, suffering during credit contractions.

Bitcoin’s unique position makes it difficult to categorize within traditional factor models. It has elements of momentum but lacks fundamental earnings or cash flow dynamics to tether its valuation. This means that Bitcoin’s momentum often follows broader equity and liquidity cycles, thriving when speculative fervor is high and suffering when macroeconomic tightening reduces liquidity. Its extreme price swings are a reflection of the behavioral elements that drive momentum: FOMO, narrative-driven enthusiasm, and reflexivity. Its recent price movements suggest that while it remains correlated with risk assets, its growing adoption narrative could eventually carve out a separate identity—one that still follows momentum but with its own distinct catalysts. This is one of the reasons why traditional finance people will always have trouble with Bitcoin. When they are getting hurt in their portfolios, Bitcoin is almost always getting hurt as well. As I have said, I see Bitcoin as being a powerful story of hope for those not benefiting from the exponential rise of technology and AI represented in the greatest momentum story of all, the S&P 500. I will get back to that at the end. That makes Bitcoin a behavioral belief which again makes it pure momentum in my eyes.

Conclusion: The Next Phase of Momentum

Momentum investing is a dynamic force, constantly evolving to reflect the dominant themes of the market. The recent unwind in momentum highlights the natural cycle of rotation that occurs at macro inflection points. Historically, these shifts take time to stabilize before the next dominant trend emerges. If AI momentum is moving beyond infrastructure and into real-world productivity gains, the market will likely see a more fragmented but fundamentally driven wave of momentum trades. The S&P 500 would stubbornly hang in there as this rotation transition occurs due to continued earnings growth driven by the continuation of rising profit margins.

Ultimately, momentum investing is as much about psychology as it is about market structure. The tendency for investors to chase what has been working—driven by human emotion, social proof, and recency bias—ensures that momentum cycles will continue to dominate markets, especially with AI as an accelerating force of efficiency and productivity. The key for investors is recognizing when sentiment shifts, as momentum’s greatest strength is also its greatest vulnerability. Ultimately, the irony is that the S&P 500 stands as the most successful momentum index, as its market-cap weighting is riding the winners—allowing the strongest companies to drive returns while weaker ones fade away.