It is not the first time I have posed this question – the market’s faultlines have been exposed for some time now, but many investors appear to have been prepared to believe that these will not widen into full-scale subsidence. As Mr Bearbull notes on page 20, it has been a decade since the UK market fell more than 7.5 per cent in a month, as it did in September, when statistically there should have been four such corrections. Indeed, investors’ default setting for a long time has been optimistic – as Mr Bearbull adds, value stocks have averaged a 3 per cent loss over the past three years; growth stocks have averaged a45 per cent gain.
That appears to confirm something else about recent investor behaviour – that momentum has become possibly the most powerful determinant of what’s being bought. And buying what’s going up has been a good strategy for long bull markets. But it is also an approach that comes with an obvious danger: no one knows when the momentum merry-go-round will stop.
By way of example of a sudden and catastrophic loss of momentum let’s look at Fevertree Drinks, whose shares have fallen by a third since touching a high of nearly £40 a share a month ago. There is no clear reason why this has happened – there have been no profit warnings or broker downgrades, and as Phil Oakley explores on page 22, it remains a genuine growth business that passes muster under the most important analytical tests. One can only assume that as the forecast PE ratio headed into the 80s, nervous investors simply decided that it was time to take profits (the PE now stands at 52).
If, as some academics suggest, widespread momentum investing also leads to the formation of bubbles, then the dangers are further pronounced – as well as investors attracted generally to rising share prices, the identification of momentum as a key factor in returns has led to the creation of numerous smart-beta exchange traded funds (ETFs) based on the strategy, sucking in billions of dollars. When the party stops, huge numbers of investors will be looking to exit extremely overbought positions simultaneously, and optimism will swing quickly towards pessimism – and fundamentals-driven value investing could finally begin its long overdue comeback.
