Momentum investing is the antithesis of value investing. Whereas value investors search for the intrinsic underlying value based on fundamentals and only invest where they see that the market price discounts such fundamental value, momentum investors do not care much about fundamental intrinsic value.
Instead, momentum investors base their investment decision almost exclusively on the psychology reigning in the market. If there is a momentum building round a particular share or a particular market sector – even if this creates serious and sometimes awesome gaps between the market price and the underlying intrinsic value which would make such investment totally inconsiderable for a value investor – the momentum investor joins the pack and simply assumes that market momentum will continue to push share price(s) forward.
History shows that money has been made under both investment philosophies. The difference is that while value investors may have to wait quite some time for the market to discover the value discount and thus produce the capital gains they desire only on a long term basis, momentum investors can generally reap their returns within a relatively short time.
The problem with momentum investing is that when the momentum peters out, as it unavoidably will once the price surge runs out of steam, there would be nothing left to support the wide gap between the market price and the intrinsic value and the value argument will have to come back into the equation. And just like a rocket that runs out of fuel it cannot keep hanging in the air; if it cannot surge forward it will have to fall back to a reasonable distance of the intrinsic value pulled by the investment value gravity.
There is nothing wrong in being a momentum investor, provided one knows what one is doing. Whoever chooses such an investment strategy must however realise that if it is too good to be true, then it is generally not true, and when the whole process would have run its course, there will be winners and losers – but the sum of the parts will be the same. Such investors have to make sure that they leave the party when the champagne is still flowing – as, the moment the champagne stops, there will only be tears for the road.
Managements of our banking sector ought to know better than all analysts that the prices of the shares of their organisations have gone out of all reasonable ranges and they have a moral duty to calm down the party before it finishes in tears. The following figures need no additional persuasion as they speak for themselves:(Table 1)
I would have thought that this stellar performance in share prices could have inspired prudence in dividend distribution policy and share splits and bonus issues, which in the current context is like putting out more alcohol at a party that has gone wild.
Such policies are encouraging momentum investing at the expense of value investing. In the interest of long-term orderly development of our financial markets, prudence should have prevailed over cheer-leading.
But prudence is also unknown to our political class – who is ever so ready to clutch at every shred of positive news to take credit for its performance in office.
The Prime Minister is repeating the gratuitous assertion that the performance of the banks in reporting record operating profit is indicative of resurgent economic growth.
This does not make economic sense to me, as it could well be that economic growth is in fact being suppressed by the oligopolistic profits being returned by the banking sector. This deserves a thesis on its own some other time.