The Economist recently published an article on momentum in the financial markets titled Why Newton Was Wrong . While I believe that in some ways the article is describing a more general form of financial market momentum, these were my thoughts on the subject, which I similarly shared with the editor. To read the article you’ll have to click on the link.
Momentum is all around us; Newton I believe first explained it, but I think he called it inertia. It exists in nature and for sure, in just about every sport I’ve ever watched, especially streaks of scoring in basketball – the hot hand. Why it does exist perhaps may not be as important as the fact that it does.
With respect to stocks, the article leaves out one glaring argument, and that is the creation of value over time, especially for companies creating their own markets and products. The reason that some companies like Apple, Cisco, Netflix, Google, Chipotle and likely Facebook do or have enjoy(ed) momentum in their share prices for long periods of time may be less about crazy investor behavior and more about the fact that these companies are or have created new markets over lengthy periods of time whose size is not yet known with any degree of precision. Often as a function of their own growth, they completely alter the value dynamics of other industries, as Google has done to newspapers and Amazon has done to brick and mortar book distributors.
For some reason, an intellectual elitism exists in some areas of the investment community that consistently paints momentum strategies in a negative light; it somehow suggests that gains made in a momentum fashion are somehow unsophisticated, blue collar, or not becoming of an Economist readership. Like any investment strategy, momentum has its faults (like value investing value traps), but my best long term winners have almost always shared this characteristic in common at one point or another.
Eventually all great things come to an end and momentum turns; sometimes as with the dot coms it may never have been justified, although even there a few very significant winners emerged. It would be an interesting exercise to take the current value of remaining internet companies and compare them to the value of all dot coms at the time to see if true wealth has disappeared or if it has simply just consolidated into fewer hands. (Amazon, Google).
Selling a LeBron James or a Michael Jordan simply because they’ve had a hot streak is usually a mistake, until its not. This latter judgment making is what makes investing more art than science and why the subject has likely been given short shrift in academia even though it has long been in existence.