Exploring Investment Momentum: The Psychological Factors Influencing Market Trends

04/16/18 • 13 min

Standard Deviations with Dr. Daniel Crosby

Momentum has existed for hundreds of years and has persisted for two decades post discovery. This sort of staying power in capital markets full of hungry arbitrageurs is always the mark of human psychology.

Many experts consider momentum to not just be a factor but THE factor. Fama and French don’t mince words, “The premier market anomaly is momentum. Stocks with low returns over the past year tend to have low returns for the next few months, and stocks with high past returns tend to have high future returns.” As James O’Shaughnessy says, “of all the beliefs on Wall Street, price momentum makes efficient market theorists howl the loudest.” In a perfect world, there would be no good reason to pay more for a business today than yesterday simply because of positive price action. But this isn’t a perfect world, it’s a world ruled by human behaviour and thus exhibits all of the attendant quirks.

Like peanut butter and chocolate, momentum and value are wonderful on their own, but even better together. Cliff Asness says it best in his piece, A New Core Equity Paradigm:

“Value and momentum remain the two strongest findings of academic and practitioner research of the last 30 years. While academics continually identify new market anomalies, which purport to offer significant risk-adjusted excess returns, and the Street routinely spins new stories to sell them, value and momentum stand head-and-shoulders above the rest-no other styles have performed so well, for so long, and in so many places. Both value and momentum have long histories of providing attractive returns, have performed well across markets and across asset classes, and have persisted for decades after their discoveries. Importantly, the two strategies perform even better when combined.” Value and quality work, independently and in concert, precisely because they exhibit the three hallmarks of an investable factor: empirically evidence, theoretical soundness and a behavioral foundation.

Like peanut butter and chocolate, momentum and value are wonderful on their own, but even better together. Cliff Asness says it best in his piece, A New Core Equity Paradigm:

Previous Episode

Understanding the Shape of Financial Bubbles: Key Patterns and Indicators

In this episode we look answer:

How do financial bubbles form?

How likely is a bubble to burst?

How can I know a bubble when I see one?

Next Episode

You Will Never Have Enough Money: Key Reasons and How to Break the Cycle

We’re all familiar with the term “keeping up with the Joneses” but it’s doubtful that we understand just how deeply ingrained this is in our concept of wealth and success. Each year, a Gallup poll asks Americans to determine “What is the smallest amount of money a family of four needs to get along in this community?” Gallup finds that the answers to this question moves up in line with average incomes of the respondents.

A recent Princeton study set out to answer the age-old question, “Can money buy happiness?” Their answer? Sort of. Researchers found that making little money did not cause sadness in and of itself but it did tend to heighten and exacerbate existing worries. For instance, among people who were divorced, 51% of those who made less than $1,000/month reported having felt sad or stressed the previous day, whereas that number fell to 24% among those earning more than $3,000/month. Having more money seems to provide those undergoing adversity with greater security and resources for dealing with their troubles. However, the researchers found that this effect (mitigating the impact of difficulty) disappears altogether at $75,000.

For those making more than $75,000 individual differences have much more to do with happiness than does money. While the study does not make any specific inferences as to why $75,000 is the magic number, I’d like to take a stab at it. For most families making $75,000/year, they have enough to live in a safe home, attend quality schools and have appropriate leisure time. Once these basic needs are met, quality of life has less to do with buying happiness and more to do with individual attitudes.

After all, someone who makes $750,000 can buy a faster car than someone who makes $75,000, but their ability to get from point A to point B is not substantially improved. It would seem that once we have our basic financial needs met, the rest is up to us.