Investing is subject to the emotions of the moment, the analysis du jour and the exogenous event that unexpectedly and instantly delivers yesterday’s pearls of wisdom to the trash heap of history. What then can the strategic investor rely on for true perspective?
In search of an answer, we suggest reviewing the basic forces that propel markets, which your editor believes to be momentum and value factors.
A number of studies over the years have boiled the primary engine of market forces down to these two drivers. And to a degree, common sense suggests no less. Momentum is simply the tendency of price trends to continue, up or down–autocorrelation, as it’s called. Value, by contrast, is a condition of excess asset valuation, either or high or low, which leads to a correction in price.
Momentum and value have a long history of generating returns, albeit in sharply different ways, with sharply different types of risks and under varying time periods. Momentum of the bull market variety can stretch out for long periods and render investors complacent with the view that what’s past will roll on indefinitely.
By contrast, bear-market momentum has a nasty habit of arriving suddenly and, save for those with a contrarian mindset, without clear warning. In addition, bear-market momentum tends to be relatively short, albeit decisive. In turn, the rapidity of its emergence delivers a fair share of what we’ll label the deer-in-the-headlight syndrome, which poses a challenge for fully exploiting the trend.
Meanwhile, the value factor exists in varying degrees over time, wedged in between the fading of bull market momentum and the soon-to-be emergence of bear-market momentum. Value’s power and influence, in short, are at a peak during periods of extreme excess in the market. At that point, and for some time after, value decisively overwhelms momentum, slowly giving way to momentum’s charms anew.