The momentum psychology

Momentum investing done by the majority of investors and fund managers today is a feel good factor that does more damage than benefit to a portfolio.

According to behavioral finance Momentum investing is at the heart of investor mistakes. But do you know whether you are a momentum investor? Putting simply, if your stock picking is news based, volume based and price based you are a momentum investor. Your belief in market movers and stories ties you to momentum. What’s good about momentum investing? The majority is with you. So there is comfort in numbers. Momentum periods can be extended and large. Not being a momentum investor could be painful as you could miss substantial price movements. Momentum investing is also more about investing in growth, winners, successful companies, stocks that are already identified as performers. The technique is about doing what the majority is doing. Be it technical oscillators which continue to suggest that the trend is running or fundamental indicators which tell that earnings continue to be good, momentum is about our need to speculate with safety that we are not alone. The technique is also about good stocks and bad stocks. Behavioral finance has written about investor’s ability to ascribe more value to the company that the market considers good and reject the ones the market thinks are bad.
Majority of the investors today are momentum investors irrespective of the technical, fundamental or quantitative approach they use in stock or sector selection. Investors don’t change their investment style because they believe in market efficiency or inefficiency. Actually the majority of investors doesn’t care or even know about the debate. The momentum psychology rules them. Even analysts and experts suffer from the momentum psychology. After the hard lessons from 2000, the street has started paying more attention to analyst’s calls against market momentum. The calls are still few. Being against market momentum is a hard skill owing to the fact that market timing tools are at a nascent stage and few attempt to do it. Being few in numbers, market timers are generally judged harshly. A prey standing alone is more prone to attack from the hunter, in numbers, probability of being killed seems low.
Life would have been easy if an investor get’s on the bus to the zoo with a group of friends and come back on his own or goes somewhere else from the zoo leaving his friends behind. Such individual behavior may leave us with few friends in real life, but unfortunately how we are in real life is how we are in markets. Very few can dissociate their economic life from their social life. We will invest together in real estates and lose together in real estate. Momentum investing is genetic, you were born with it and to comprehend, question and change it is a monumental obstacle. Once in a while you might say “Wow!! I was smarter as I exited earlier”, but till the time you break the momentum psychology and social thinking you are and will be a momentum investor whose luck may not protect him every time.
Some investors may now say, we relate to this and this is why we look for smart money managers. Looking for performance in money management is an extension of momentum investing. History of market literature has proved that your fund manager did not beat the benchmark over the long term. So what are you left with? In the end market is the best performing benchmark and all your effort is a waste of time, if all that internet and news and research gets your portfolio returns marginally higher or lower than the market why not just buy the benchmark.
I am trying to convince you that if the investment approach where you are the fund manager (or you chose one) does not beat the benchmark, you need to restrategise and rethink the value of your time. It’s not easy for a money manager to tell this to his clients (that he screwed up), but this is the hard truth. Not very many managers will tell you this, what they will show you is how the comparable benchmark has done or how risky was the portfolio. We don’t judge our money managers harshly because we are in love with them and this is why there is no real alpha just beta. If you think the idea is going too fast in challenging your mindset, you should read Robert Arnott’s, Fundamental Indexing. Arnott runs Research Affiliates and has challenged the benchmark creation itself. According to him the way we construct our benchmarks is itself flawed and even the case for indexing is weak. Benjamin Graham (father of security analysis) proposed the case of indexing as superior stock selections get tougher. If the gods of fundamental investing dissuade you from stock selection and push you to passive index investing, you as a reader have to judge where you and your fund manager are on the learning curve.
Actually my aim is not to convert or dissuade you against riding the trend, be a momentum investor because without what the majority does with momentum psychology there would be no market. Very few market literatures really acknowledge this economic role. Momentum investing creates the economic cycle. Who is not a momentum investor? A person who does not bet on trends, news, and price movement but on sentiment extremes, low risk entry points and value. This is how growth and value cycles are created. Momentum investor pursues growth takes it to unsustainable extremes when the cycle turns and brings on value purchasers who give prices support.
According to a paper on growth and cycle written by Arnott, the market did a good job in differentiating between growth and value, but that the market discounted the value companies too deeply and paid about 50% more premium for growth companies, relative to the value companies. Although growth stocks (those trading at high multiples) do historically exhibit superior future growth, the premium carried in their market price is too high to be justified by reality. Arnott talks of distinct pattern in time i.e. periods that begin with low valuation (growth stocks prices at a small premium to value) followed by fast rising valuation (major rally for growth stocks). For spans of 20 years or more years, the market never failed to overpay for the long term realized successes of the growth companies. Value has outperformed growth in most years, in most markets around the world for decades. Have we learned from this experience? Investors have always paid more for premium stocks than value stocks? Arnott’s fundamental indexing has an overlap with Behavioral finance, which also talks about buying the winners and selling the losers. Are both of them not talking about performance cycles? And how without understanding the Cycle (Time) investing is incomplete and just momentum driven?
ORPHEUS RESEARCH AT REUTERS – UNITED KINGDOM
ORPHEUS RESEARCH AT REUTERS – USA
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