There are a range of so-called anomalies that have preoccupied investors for many years, largely because they seem to offer a free lunch, which is a rare thing in investment markets. So the momentum effect and various value-related effects have spawned a whole host of exciting but not entirely convincing ventures. A range of recent research now threatens to actually shed some light onto these anomalies suggesting that the momentum effect has vanished and that value effects are real but caused by idiosyncratic factors. It also suggests that mean reversion, upon which many investing careers is based, generally works but sometimes only if you have an investing lifetime to wait.
On a positive note, NOW might be a really good time to try and exploit it.
Losing Momentum
The momentum effect was first documented by Jegadeesh and Titman, who established that a strategy of holding a portfolio of winning stocks and shorting losing stocks yielded a positive and abnormal return over timescales of up to a year. This finding generated a whole host of related research dedicated to explaining the effect, most of which was mutually contradictory and which makes you go cross-eyed from reading it. One of the odd things we've noted in the past about this type of anomaly is that actually pointing them out often has the affect of causing them to disappear. The explanation for this, at least, is relatively clear cut: once the effect becomes generally known then investors will move to exploit it, and improve the efficiency of the markets in that respect. We've seen a similar occurrence in the Death of the Accrual Anomaly.
This seems to be what's happened to the momentum effect as Bhattacharya, Kumar and Sonaer document in Momentum Losing Its Momentum: Implications for Market Efficiency. Since 1999, roughly when Jegadeesh and Titman published a follow-up paper showing that the momentum effect was still current, it's disappeared. M. Scott Wilson in Are Momentum Strategies Still Profitable Work for U.S. Equity? records a similar result, and actually shows that momentum effect returns have been negative in the last five years.
Valuing Ignorance
So if momentum's stopped working what about its polar opposite, the various value effects? The size effect – where small companies outperform large ones – and the book-to market effect – where companies trading at or below net asset value outperform the market –…
