A Nobel Prize Winner’s Market Advice

Nobel Prize-winning economist Eugene Fama and other researchers have found that momentum strategies have worked for over 200 years.

A bell chimed as I walked through the restaurant’s door. The owner, a middle-aged man with a thick Jersey accent and thinning hair, smiled with all his teeth and asked me what beer I wanted.

He was a friendly guy, and after I purchased way more food than I intended, we somehow got to chatting about his life — particularly how he ended up as a shop owner in South Florida.

I won’t go into all the details — it was an interesting two-hour-long chat — but the man used to have $5 million to his name … and he recently lost it all. Every single cent. But instead of sitting around, lamenting his unlucky loss in life, he decided to start again from scratch.

He picked himself up by his bootstraps and, imbued with that American entrepreneurial spirit, he began his own business — one that now has lines of people snaking into the street during lunch hour.

So what was his secret?

During our talk, there was one word he used that stood out to me: momentum. He needed to gain it back to be successful again, so he focused on building it up.

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Momentum is a term you might have heard in the investing world, which is why it struck a chord with me.

See, traders tend to fall in love with stocks that have momentum — because that, as it did with the shop owner, often fashions a swift path to success. After all, it’s one of the most popular indicators on Bloomberg.

But is momentum trading really as good as it’s cracked up to be? There are so many myths surrounding investing nowadays, I wasn’t sure. So, I asked our momentum expert — Mike Carr — if this was a top trading strategy, and his answer didn’t really leave any room for doubt:

Here’s part of what he told me:

Yes, momentum investing is simply recognized by academics and finance professionals as a way to beat the market.

Now, this might be surprising. The academic community usually says you can’t beat the market. This is the basis of the efficient market hypothesis (EMH).

But finance professors have found a few anomalies to that hypothesis. (An anomaly, in this case, is what they call a “market-beating strategy.”) For example, value stocks are an anomaly that can beat the market in the long run — which is, more often than not, measured in decades.

For investors who can’t afford to wait that long, there’s the momentum anomaly.

At least, that’s what a Nobel Prize-winning economist thinks.

Eugene Fama shared the Nobel Prize in Economics in 2013 for his leading the development of the EMH. However, since doing that work in the 1960s, he’s become more familiar with momentum, and he’s said: “The premier anomaly is momentum.”

Not to mention other researchers have found that momentum strategies have worked for over 200 years.

Maybe you’re now asking yourself (like I am): If this strategy is so good, why don’t more traders use it?

Mike tells me that data for following a momentum strategy is pretty difficult to gather. In fact, to do so, you’d probably need to subscribe to an expensive data service like Bloomberg for more than $20,000 a year. Or you’d need to get raw price data for all publicly traded stocks, then program your own indicators.

Most people simply don’t have the time to do that. I know I don’t.

Of course, you could also follow a momentum ETF (exchange-traded fund). I’ve been taking a look at a few recently, such as the iShares MSCI USA Momentum Factor ETF and SPDR Russell 1000 Momentum Focus ETF — and both have been climbing higher for years, pretty much in line with the bull market.

However, it seems there are risks to using ETFs for your momentum strategy. See, when the market drops — or even moves sideways — momentum ETFs will likely take the biggest hit.

As Mike says: “Regulations will limit the ability of the manager to react to the market — and the ability to react, rather than trying to predict the market, is the reason momentum strategies work. So momentum managers, unhampered by ETF rules, will react best to the market’s ups and downs.”

That’s actually why he decided to put together his own service for momentum traders, which you can learn about here. And why it’s been doing so well — all three open positions are profitable right now.

So if you’re an investor searching for a new strategy to add to your portfolio, you might want to consider momentum investing — but just remember to be leery of ETFs.

Sometimes life can take an unexpected turn, like it did for that shop owner, and you want to have a reliable system for finding your momentum again. At least, in this case, there’s a literal way to do that.

Catch you next week.

Regards,

Jessica Cohn-Kleinberg
Managing Editor, Banyan Hill Publishing