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Here's Why We Don't Encourage Momentum Investing January 12, 2018
In this article, we would like to discuss what is momentum investing and whether investors should adopt such investment strategy.
Author : Jerry Lee Chee Yeong


Idea of The Week: Here's Why We Don't Encourage Momentum Investing [12 January 2018]

Global equities markets have romped to fresh all-time highs with the S&P 500, Nikkei 225 and Hang Seng Index extending their rallies into 2018 (see figure 1) and even the ASEAN market such as the Thailand and Malaysia stock market surging more than 1% during the first trading week in 2018. According to the Bloomberg research, the number of all-time highs for S&P500 has more than 50 times in 2017. On top of that during the month of September and October 2017, the number of such peaks exceeding 20 times, which is more than the total number of all-time highs in the entire decade of the 2000s (see table 1). Given the robust performance of the global equity market, one might argue that the momentum investing strategy would be one of the most profitable investment strategy in 2018. As such, in this article, we would like to discuss what is momentum investing and whether investors should adopt such investment strategy.

Figure 1: MSCI World Index and S&P 500 Index

Table 1: Number of new all-time high for S&P500

Period
Number of new all-time highs
1950s 141
1960s 224
1970s 35
1980s 196
1990s 304
2000s 13
2010s 174

Source: Bloomberg, iFAST compilations. Data as of 5th Jan 2018

What is momentum investing?

In practice, momentum investing involves the decision of purchasing stocks that have been performing relatively stronger and selling stocks that have been performing relatively weaker. In another word, momentum investing encourages one to buy high and sell higher. In fact, the concept of momentum investing can be explained by the first law of motion discovered by Sir Issac Newton which stated that “an object at rest stay at rest and an object in motion stays in motion with the same speed and in the same direction unless acted upon by an unbalanced form”. Similarly, in the stock market, a rising market tends to attract more buyers whereas a falling market tends to attract sellers, which can be explained by a few behavioral biases such as overconfidence and herding effect.

What are the risk of momentum investing?

Momentum investing has nothing to do with the fundamental of a security. Hence, it might be contradicting to value investing which emphasize on the fundamental or intrinsic value of a security. Momentum oriented investors often chase after the best performing security thus pushing the stock valuation sky high. In fact, security with a sky-high valuation tends to be more vulnerable to earnings disappointment or any sudden change in economic front.

On top of that, by adopting momentum investing strategy, investors favor securities with the best trailing 12-months returns and try to shun those that have performed badly. In fact, it simply means that this strategy work well for a smooth trending market. As such, it involves certain level of market timing as investors have to identify and avoid those periods of high market volatility and market inflection points.

Momentum investing requires high level of discipline. However, generally, investors tend to be greedy when the market is holding up, vice versa. Therefore, for indiscipline investors, the huge market gains prior to a market inflection point may seduce investors into investing even more money. Hence, he/she might end up losing their hard-earned capital when the market turns around.

Should I adopt such strategy in 2018?

We do understand that momentum investing strategy has its value given the solid academic backing. However, at Fundsupermart, as we see ourselves as value investors, focusing on the fundamental and valuation of securities or markets, we do not encourage our investors to practice such strategy. On top of that, given the stellar performance from the global equity market, most of the global equity market valuation has been lifted significantly as compared to early 2017 and majority of these equity markets have priced in a positive earnings growth even with relatively higher forward earnings multiples. Hence, after the robust performance in 2017 and given the high earnings expectation, momentum oriented investors might end up buying into securities with rich valuation, causing the assets to be susceptible to earnings disappointment.

Conclusion

All in all, although we do expect an environment of accelerating economic growth in 2018, we might see increasing volatility this year as some other Central Banks are likely to join the US in normalising the monetary policy, which could lead to lower excess liquidity in the financial system. As such, we would like to advocate our investors to focus on the market fundamental – valuation and earnings growth. At this juncture, we continue to view the Asia ex Japan and Emerging market as better investment opportunities to deliver investors with potential capital growth.

For investors who want to discover more investment opportunities, you can join our annual Unit Trust Investment Fair: What and Where to Invest in 2018! Alternatively, investors can also read our in-house research view for 2018’s outlook.


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