In this blog we present our summary of the 5th video in the series where Momentum factor has been discussed. (Emphasis Ours. The screenshots have been taken from the presentation given by Rajeev Thakkar).
Battle between Fundamental Bhagwan Che VS Bhav Bhagwan che
The dumbest reason to buy a stock is because it is going up. - Warren Buffet
It doesn’t matter how beautiful your theory is, it doesn’t matter how you are. If it doesn’t agree with experiment, its wrong. - Richard Feyman
What does evidence say about past prices and future price behavior:
Simple momentum implementation
àBuy stocks which have had the highest percentage price performance (increase) in the last 12 months (top 10%)- excluding last month
à Sell stocks which have had the lowest percentage price performance (highest fall percentage) in the last 12 months - excluding last month
Over multiple years you would have made money. Evidence shows this strategy works really well. Long only portfolios also work if you want to avoid short selling
Two variants of Momentum
- Time Series Momentum - If stock price has gone up positive momentum, if it has gone down, negative momentum.
- Cross sectional momentum – Look at relative performance of the asset, Buy Relative Out performers, Sell Relative under performers
Value and Momentum Everywhere
Momentum Investing is not Growth investing
Momentum investing looks at stock price, it might or might not have growth. Largely Price and maybe Volume is what is considered in Momentum investing.
Intraday, Daily, Weekly, Monthly (Not that big a signal)
6 months to 1 year (gives good direction of momentum)
3 years to 5 years (Mean reversion)
Relevance of Momentum for Value Investor
- Avoid behavioral biases
- Negative correlation between Value and Momentum, if combined can save from drawdowns.
- Two sides of same coin
- Value investing- Seek benefit from where fundamentals are far stronger than the market price suggests
- Momentum factors in under reaction of investors to positive developments and the excessively conservative nature of investors
- Momentum also captures price as a leading indicator of fundamentals (In some cases stock prices crashed way before the fundamentals reflected and credit rating agency companies still had high credit rating it was only when the defaults happened that the credit rating were updated)
Momentum and Value not necessarily in opposition
As Howard Marks says over a period of time the stock prices attracted towards fair value. Stock price rarely spend a time at fair value it keeps oscillating between undervalue and overvalued. Fair value of a company acts as centre gravity for the stock price.
Behavioral Biases of Value Investors
- Anchoring Effect:
- Stock at 52 Week high is expensive, Stock at 52 weeks low is cheap. However, this is not correct, a stock which has been at 52 weeks low for a year has probably negative price momentum and it will keep falling and vice versa.
- Underreaction to earnings events, etc. – As shown in the graph below the rational price should increase after the good news in a step manner but it doesn’t mean stock price will increase in a similar fashion. Stock price will start increasing slowly and might overshoot the fair value. So, the green part in the underreaction where the investors have not completely priced in the fair value and the because the stock prices have been going up it overshoots (over reaction).
Fundamental sins of value investor
- Buy too early
- Sell too early
If you want to buy low/sell high
- Look at 3-to-5-year lows and highs not 52 week – If the stock has underperformed for a very long time, then probably it is time for mean reversion.
Do not Forget
- Equity ownership is ownership of a business
- Stay away from bad quality with good momentum – Frauds, Stock price manipulators, earnings manipulators, etc
- It’s okay to leave the party a bit early, do not wait till the clock strikes 12
- Smooth momentum is better than jumpy momentum – a stock is better if it gradually goes up in a year rather than it has been flat for a year and suddenly jumps
Problems with momentum
- Higher Churn, Brokerage, tax – Signals last for a shorter period of time than value factors. Monthly quarterly Rebalancing required for Momentum VS Annual bi Annual for Value factor
- Like every other factors doesn’t work all the time