Momentum is a fascinating investment phenomenon because it can be exploited in two completely opposite ways. Value investors profit if they successfully bet that the momentum has gone too far and will reverse direction, whereas momentum investors profit if they successfully bet that momentum will continue in the same direction. Isaac Newton’s first law of motion is:
An object in motion tends to remain in motion, an object at rest tends to remain at rest.
Newton’s experience in 1720 investing in the South Sea Company demonstrated both the promises and pitfalls of momentum investing. He initially bought some South Sea stock and then sold it after momentum had earned him a 100 percent profit. Presumably, he sold the stock because he thought the stock’s momentum was about to reverse. But the stock kept going up and Newton decided to jump back in right at the top, expecting the momentum to continue, only to watch the momentum peak and reverse and he ended up losing not only all of his earlier profit but much, much more. Newton famously stated: “I can calculate the motion of heavenly bodies, but not the madness of people.”
Momentum by its very nature continues in the short term and reverses in the long term. A rubber band can stretch very far, but it eventually snaps back.
We recognize Portfolios need to be rebalanced on a regular basis in order to keep our clients in the sectors with upward momentum and out of sectors with downward momentum.