The Economist Chimes in on Momentum - Students Post

I think I’m on a roll with this media thing. Today’s Economist has an article out on momentum investing that is probably worth your time:

It is also given a mention in the venerable Leader section.
However, whoever wrote the article has in my opinion a very poor understanding of proper momentum investing:

A second puzzle is why the effect has not been arbitraged away. The answer probably lies in timing. Clearly the momentum effect cannot last for ever or share prices would head for infinity. Over long periods (more than three years or so) an opposite anomaly known as the value effect occurs: shares that are depressed in price tend to rebound. Momentum-chasing investors may get caught out by the switch from one effect to the other, especially when they have used borrowed money to try to enhance returns.

This is an unforgivably stupid reason even by their chosen strategy.

Investors who buy the best-performing shares over the previous year earn much higher returns (ten percentage points a year) than those who buy the laggards of the preceding 12 months.

By definition momentum investors cannot be “caught out” by the switch to the 3-year value effect if their momentum horizon is 12 months.
This Student suggests the eggheads at the Economist read up on Cliff Asness’ seminal Value and Momentum Everywhere for a better way to compare value and momentum directly, and for some more informed ruminations on more likely sources of momentum profits.
in my view
The easiest explanation for why momentum investing continues to exist is that it is the one market inefficiency that is impossible to arbitrage. Typical arbitrage involves some conception of the market price being different from fair value, and the trade profits from the market price moving in the opposite direction of the pricing discrepancy. If momentum is real, fair value is a function of market price and the trade profits from the market price moving in the SAME direction of the pricing discrepancy. Attempting to “arbitrage” the momentum effect makes it stronger, not weaker, unlike in all other arbitrage scenarios.
One further comment on momentum: This has obvious links to Soros’ reflexivity, but at least he grounds it in the effect that accessing the capital markets can have on the fundamental fair value of a company. True momentum doesn’t even wait for the stock price to affect the company’s fundamentals; the stock price affects the stock price, and that is that.