The Changing Nature of Momentum Investing

Episode Summary

Executive Summary: The episode examines how momentum investing works, why it’s hard to define, and why it changes over time unlike more stable factors such as value or quality. Using database analysis, the hosts show that even long-term growth leaders were not consistently top momentum names, and that momentum’s factor exposures shifted sharply from low volatility to value over the last year as market leadership changed.

Main Topics: What momentum is and how it is measured (Priority: 5/5): Jack distinguishes time-series momentum from cross-sectional momentum and explains that the discussion focuses on 12-minus-1 momentum, which ranks stocks by intermediate-term returns excluding the most recent month. Why momentum is harder to understand than other factors (Priority: 5/5): Unlike value or quality, momentum does not map to a stable set of company characteristics; it simply follows recent price strength, which can shift among growth, value, low-volatility, or low-quality stocks. Momentum vs. growth stocks (Priority: 5/5): The conversation challenges the common assumption that momentum is synonymous with growth, showing that even major growth leaders like FAANG names were not in top momentum deciles very often over the past decade. Evidence from FAANG stock inclusion (Priority: 4/5): Jack cites data showing the largest growth names were only intermittently present in the top 10% momentum cohort, illustrating that long-term winners are not always intermediate-term momentum leaders. Momentum’s changing factor exposures over time (Priority: 5/5): A comparison of momentum portfolios in March 2020 versus March 2021 shows a major shift in exposures, especially away from low volatility and toward value, reflecting the market’s changing leadership. How momentum works and why it persists (Priority: 4/5): The hosts describe the core behavioral explanation: investors underreact to good news in the intermediate term, allowing stocks with positive trends to keep outperforming. Practical implications for investors (Priority: 4/5): Momentum can be powerful, but because it rotates across stock types, it may not suit investors who want a consistent fundamental story for every holding.

Key Arguments: Momentum should be defined as intermediate-term price strength, not as a permanent style like value or quality. Cross-sectional momentum, especially 12-minus-1, is the relevant concept for stock selection; it ranks stocks against one another rather than against themselves. Momentum is difficult for investors because it can lead to any type of stock, including low-quality, high-quality, growth, value, or small-cap names. Even in the growth-dominated decade, many major growth stocks were not frequently in the top momentum decile, showing growth and momentum are not the same thing. Momentum portfolios shift as market leadership shifts; this is why factor exposure can look very different from one year to the next. Market-cap-weighted indexes can function like a weak or lagged momentum implementation, but they overweight past winners for too long and do not rebalance on an intermediate-term basis. The main behavioral reason momentum works is that investors tend to underestimate good news over the intermediate term, allowing winning stocks to keep rising. Momentum is best suited to systematic investors who are comfortable owning names without a strong fundamental narrative at purchase time.

Data Points: Investable universe size: about 2,800 companies - The database used in the analysis covered roughly 2,800 investable stocks. Top momentum cohort size: top 10% / about 280 companies - Jack analyzed the top decile of momentum stocks within the database. Facebook in top momentum decile: 14% - Frequency of Facebook’s inclusion in the top 10% momentum stocks over the past decade. Netflix in top momentum decile: 44% - Frequency of Netflix’s inclusion in the top 10% momentum stocks over the past decade. Amazon in top momentum decile: 21% - Frequency of Amazon’s inclusion in the top 10% momentum stocks over the past decade. Apple in top momentum decile: 16% - Frequency of Apple’s inclusion in the top 10% momentum stocks over the past decade. Google in top momentum decile: 3.6% - Frequency of Google’s inclusion in the top 10% momentum stocks over the past decade. Momentum exposure to value on 3/26/2020: 29 - Top momentum stocks had relatively low value exposure near the market bottom. Momentum exposure to quality on 3/26/2020: 40 - Top momentum stocks had moderate quality exposure near the market bottom. Momentum exposure to low volatility on 3/26/2020: 40 - Top momentum stocks were heavily exposed to low-volatility names at the 2020 market bottom. Momentum exposure to value on 3/26/2021: 35 - Value exposure increased in the momentum basket over the following year. Momentum exposure to low volatility on 3/26/2021: 22 - Low-volatility exposure fell sharply as those stocks underperformed over the year.

Pivotal Quotes: "all you should care about is the stock price has gone up and you shouldn't care why" — Jack: Explaining the defining logic of momentum investing and why it can feel disconnected from fundamentals. "momentum is whatever those things are at any given time" — Jack: Clarifying that momentum does not correspond to a fixed style such as growth or value. "people tend to underestimate good news in the intermediate term" — Jack: Describing the behavioral explanation for why momentum can persist as a factor.

Implications: Momentum is powerful but unstable as a style exposure; investors using it must accept rotating holdings and shifting fundamentals. It is best implemented systematically and with a long horizon, not as a static list of favorite stock types.