Momentum is the rule, not the exception. It is how the world generally works, not an anomaly. We really should be less surprised to learn that research suggests that momentum is an effective way to generate excess returns over time. Momentum is pervasive, both in the financial markets and in life in general. I was struck by this passage in Andre Agassi’s autobiography, Open:
Our best intentions are often thwarted by external forces—forces that we ourselves set in motion long ago. Decisions, especially bad ones, create their own kind of momentum, and momentum can be a b*@!~ to stop, as every athlete knows. Even when we vow to change, even when we sorrow and atone for our mistakes, the momentum of our past keeps carrying us down the wrong road. Momentum rules the world. Momentum says: Hold on, not so fast, I’m still running things here. As a friend likes to say, quoting an old Greek poem: The minds of the everlasting gods are not changed suddenly.
Agassi wrote this about a period in his life (around 1997) that was filled with defeat (both personal and professional), drugs, and yet a desire for a change for the better. Agassi found that past decisions created a momentum-effect in his life that made it very difficult for him to change course. Eventually, Agassi was able to right his own ship in many ways, including returning to the top of the tennis world to win the 1999 French Open and, as he writes in his book, discover a much deeper sense of purpose by embarking on an effort to bring charter schools to at-risk children and communities. Fascinating autobiography and worthwhile read.
These same principles apply in the financial markets. Some companies do thing better than others—think culture, incentives, vision, etc. Those companies that are more successful than their peers tend to have their stock prices rewarded accordingly. Furthermore, those companies that perform better than their peers often do so for extended periods of time. In other words, there is momentum in the underlying fundamentals of the company which tends to lead to momentum in the price of its stock. The best companies tend to get overbought…and then stay that way for extended periods of time. The opposite is also true, once a company becomes an underperformer it can stay that way for years at a time. The result is that far from the market being statistically normally distributed, the market actually has fat tails. Consider the following from The Capitalism Distribution published by BlackStar Funds a number of years ago.
If, by employing a disciplined momentum strategy, you are able to capture a bunch of the returns of those positive outliers and avoid much of the negative outliers, your chances of generating favorable returns over time are very good.
Thus, before you refer to momentum as an anomaly in an otherwise efficient market, you might pause and ask yourself if momentum is really a deviation from the normal order of things. For me, it fits right into the pattern of life.
A relative strength strategy is NOT a guarantee. There may be times where all investments and strategies are unfavorable and depreciate in value.