Momentum Investing: A Potentially Profitable Strategy Until It Isn't
In 2020, momentum investing began generating significantly higher returns than other strategies, a trend that continued into 2021. This is largely due to the substantial amounts of stimulus that were injected into the financial system. Momentum investing, which involves buying stocks that have been increasing in price recently and selling those that have been falling, has been hailed as a successful strategy by several analysts and money managers.
However, the question arises: is momentum investing always the best approach? Or do different market conditions require different strategies?
Momentum Investing: Not a Passive Strategy
To understand the effectiveness of momentum investing, let's consider the performance of three Exchange Traded Funds (ETFs) from 2014 to the present. We'll use the SPDR S&P 500 ETF (SPY) as the "buy and hold" proxy, the iShares Momentum ETF (MTUM) as the "momentum" proxy, and the iShares Value ETF (IVE) as the "value" proxy.
Upon initial analysis, it appears that momentum investing was the most profitable strategy when compared to the S&P 500 or value investing. However, it's important to note that momentum investing is not a passive strategy. The holdings of a momentum ETF, such as MTUM, change as market momentum shifts.
For instance, at the end of 2020, healthcare-related stocks were among the top 10 holdings due to the pandemic. By September 2021, these were replaced by stocks related to the steepening yield curve and developments in vaccines and bitcoin. As we move into 2022, the holdings have once again shifted.
Momentum Investing: Not Always the Winning Strategy
While momentum investing has proven successful in certain periods, it's not always the winning strategy. This is particularly true when considering passive investment in an ETF.
Momentum investing is most valuable when applied to a portfolio of individual equities. It can help avoid significant capital destruction during market downturns. However, this value is lost when applying an active strategy to a passive holding.
Choosing the Right Strategy for the Right Time
Momentum investing can be an effective strategy when applied correctly to a portfolio of individual securities, especially during a strongly trending bull market. However, it's important to remember that strategies should change with both economic and market cycles.
The Return of Value Investing
While momentum investing has had its moment in the sun, it's important not to abandon fundamental analysis. It's also crucial to remember that all things are cyclical, including investment strategies.
The rotation from momentum to value investing is inevitable and will likely occur against a backdrop of economic weakness. This could lead to a price discovery for investors who have been lulled into complacency following years of monetary interventions.
Bottom Line
Momentum investing can be a profitable strategy, but it's not always the best approach. It's crucial to consider market conditions and adapt your strategy accordingly. The inevitable rotation from momentum to value investing could present new opportunities for gain.
What are your thoughts on this topic? Do you think momentum investing will continue to outperform other strategies, or do you foresee a return to value investing? Share this article with your friends and let's get the conversation started. Don't forget to sign up for the Daily Briefing, which is delivered every day at 6 pm.
