What goes up...? Momentum in investing

A recent article in The Economist newspaper, entitled "Why Newton Was Wrong", explores the effect of momentum in investing. Several studies, presented in the article, have all demonstrated that picking the best performing stocks from the previous 12 months would provide market-beating results. Moreover, this momentum effect exists for other securities markets, such as commodities and currencies, and has been observed for decades.

While several other stock market "anomalies" have been observed and then disappeared due to exposure, the persistence of the momentum effect had been a mystery. Nonetheless, the Economist puts forth possible explanations. Namely, the momentum effect may represent a lag between the perception of companies and their actual results. When investors have a negative view of a business, they tend to dismiss positive news about it as a blip. Then when the good news continues, they pile into the stock. Moreover, the effect may be carried over as fund managers proceed with "window-dressing" their portfolios by buying securities that had recently gone up, thus contributing to further boost stem.

Momentum strategies have been devised over the past to exploit the effect. These strategies have grown more complex, sometimes involving trading at incredible speeds. However that has made some of those strategies vulnerable to random movements in the markets. Moreover, momentum investing, over long time periods, loses out to value investing as prices of unfavored securities are driven down to bargain territory. It is noted that momentum investing has tended to misfire horribly at times and the article muses that the strategy may be behind  the creation and maintaining of asset price bubbles. Some of this was not necessarily unknown in value investing circles. In its "What Has Worked In Investing" paper, noted value investing firm Tweedy Browne cites studies that point out how value investing outperforms momentum investing over periods longer than 12 months. Some of this had also been reprinted in "The Little Book of Value Investing" by the late Christopher Browne, former director at Tweedy Browne.

Why Value?

I figure the first subject to explore is why am I doing this blog and how I came about upon value investing. It took me a somewhat elongated route to get there, though not necessarily a convoluted one, just long. In hindsight the signs were probably there somewhat. I wasn't raised with a background in finance or business or the like. Even in my extended family it's not a reoccurring interest, and this also wasn't a topic that was discussed much, if ever. Nonetheless, as far back as my early teens when I started getting interested in reading newspapers, I was immediately drawn to the business section. Mind you, like any hockey-loving teen, nothing took precedence over the sports section but business quickly became another favorite as I became interested in what companies did, how they made money and how the stock market functioned.


My first stock pick was in my first economics class, in high school, at 15. It was in Biochem Pharma, a medium sized Canadian pharmaceuticals.  Back then I had no concept of investing, reading financial results or what not, I merely picked that company because it had popped up quite a few times in the news, usually with good news. Then I watched the stock price go down more or less continuously as the company was then appearing in the press but with bad news. (Not much later, Biochem Pharma ended up being absorbed into Shire PLC, of the UK).


In spite of this inauspicious start to an investing career, I was not deterred from doing some more research into the investment industry. I graduated from university with a bachelor's degree in business administration. There I first became aware of the securities analyst profession. At the same I did a lot of reading on investing and the stock market. Early on, I found that the Value investing philosophy made the most sense to me. The most logical way of investing is to buy a stock trades beneath its value, not on what it may or may not do next quarter. Furthermore stocks are more than just symbols to play around with like a lottery, they represent ownership in a real business. Therefore the soundest way to approach investing is through the view of a business owner.

I now spend a lot of my free time reading. There's a lot of interesting books on the subject of value investing and its approaches. I also dedicate time to perusing the financial statements of companies that might interest me, both for my own real portfolio, as well as for my electronic portfolio, which will only include businesses after I have researched. You can only better at things by practicing and I intend to accumulate lots of experience. The goal of this blog is therefore to gain experience by chronicling my own reflections on investing, my picks and recommendations, as well as presenting business and investing news that I find particularly interesting. Thus far I have a bit over 2 years experience at investing and I'm looking forward to learning more and refining my style. Professionally, I'd love to get into security analysis or portfolio management as a career as I find it fun to learn about different businesses and I'm currently studying to obtain the CFA designation. I don't expect all my decisions to be home runs and like any good investor I expect to see some losers but this is a thoroughly enjoyable interest and I hope everyone can enjoy and benefit alongside me.