The falls in the share prices of several high profile technology stocks certainly caught the attention of momentum investors in the fourth quarter of 2018. But how should we view this in the context of history? And what would the late, great, Notorious B.I.G. have to say about it all?
For those who caught the title reference to the song ‘Mo Money Mo Problems’: nice work*. Having been released in April 1997, this track could have been the anthem for (and may have even been a coordinated effort with) the paper ‘On the Persistence in Mutual Fund Performance’, which appeared in the March 1997 Journal of Finance only a month earlier!
Why? Well, the concept of momentum investing is literally about pouring more money into ‘who’s hot’. What is generally absent from financial literature, though, is a discussion of when the strategy fails, which the lyricists clearly knew a lot about. So, why would momentum lead to mo problems? Let’s explore.
High momentum stocks are typically more sensitive to market swings: better on the way up, but worse on the way down
To the investing public, momentum is like the Juggernaut… the unstoppable force! But this unstoppable force only tends to work in bull markets: crumbling when what has gone up comes crashing down, as was the case in several tech stocks in recent months. Technically speaking this is because high momentum stocks are typically more sensitive to market swings (better on the way up, but worse on the way down). Furthermore, research suggests that the more protracted the bull market run, the higher the potential for a devastating relative drawdown.
Here are some not-so-fun stats on the downside of momentum:**
Wait… that last bullet sounds good! You’re right! It does sound good, and speaks to the potential benefits of harnessing this type of strategy. However, long holding periods coupled with the ability to stomach drawdowns are important warning labels for this factor. For a strategy that thrives on 'mo' money for its survival, the Chuck Prince quote is quite applicable: “… as long as the music is playing, you’ve got to get up and dance”, and momentum is still dancing!
*Please note, the title is intended to portray what I think about the current state of this particular factor, as well as to pay appropriate homage to past hip-hop greats…
**Using MSCI USA and MSCI USA Momentum monthly data from January 1975 through November 2018
We take a look at what makes the fastest factor tick...