- Is reduced share trading by retail investors making momentum a more powerful force?
- Could momentum’s increased influence result in a more powerful resurgence of value?
Readers of our Ideas Farm pages may have become familiar with the occasional appearances made by our “style” chart. The chart aims to provide an idea of how effective different investment approaches (value, quality, growth and momentum) have been over the last three months.
We’re far from alone in being interested in what forces are driving returns.
Broker Liberum, which also tracks investment styles, has recently put forward some interesting reasons why one style, “momentum”, may have enjoyed such success over recent years. And the logic of its argument has potential ramifications for the longevity of this week’s sharp rotation by markets away from “growth” stocks and into “value”.
The broker highlights findings from research into the Chinese A- and B-share markets from Hong Kong Polytechnic University, and the Universities of California and Texas. These markets are fertile grounds for researchers into investor behaviour because A-share trading is dominated by domestic retail investors and so-called “noise” traders in contrast with B shares, which attract significant money from overseas professional investors. In research terms, this is like having a “control” group; a rare luxury for finance academics. A central finding from comparing the markets was that B shares demonstrated much more “momentum” than A shares.
For Liberum investment strategist Joachim Klement, a major potential insight is: “ ...the lack of noise traders in the B share market creates a bigger impact from the herding behaviour of professional investors... enhancing momentum. This, in turn indicates that with the continuing decline of retail trading and the shift towards active and passive investments managed by professional managers, the momentum effect could remain the dominant factor.”
There is a flipside to this observation, which is that the market’s unloved stocks may be becoming more unloved… at least until something dramatic happens to cause a mass reassessment. And this week we’ve certainly had a dramatic event.
The combination of the US election result and a potential vaccine breakthrough has prompted a sharp move away from the dominant momentum theme of “growth” into unloved “value”. The outperformance shown by value over three months in the accompanying chart is down to this.
The observations made by Mr Klement have two potentially interesting implications for this ferocious swing in sentiment towards value.
Firstly, if momentum has become a stronger long-term force in markets, it’s possible that the most unloved sectors and stocks have become very excessively over sold. They could therefore have a lot of ground to make up (“mean reversion” in City jargon).
Second, if that's true and value’s recent fillip manages to develop into a lengthier period of outperformance, then “value” should become the beneficiary of the turbo-charged forces of momentum; meaning value investors could benefit more, and for longer, than would otherwise be the case.
Indeed, the beauty of momentum is its loose attachment to fundamental analysis. While it gets caught out by sharp changes in trend, it soon adapts and takes up the mantle of the latest “style” that appears to be working.
The caveat to all this (and it's a biggie) is that “value” has had many false dawns during its recent decade of dire underperformance.