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Rekenthaler Report

Living in a Momentum World

Rekenthaler defends momentum, the last market anomaly left standing.

Trend Setting
Momentum investing is smoking. (By momentum investing, I mean the practice of buying a stock simply because it has already risen.) In 1999, the Nasdaq Composite had the greatest gain ever for a major U.S. stock index, and so far this year it is appreciating at an even-faster clip. Propelling the index has been a horde of huge winners. Over the past 12 months, 200 Nasdaq National Market stocks have gained more than 500%, and almost 300 more between 300% and 500%. Heck, you don’t need the numbers to know the story. Just listen to almost any investment conversation.

You probably think I’m going to bemoan the existence of all these thoughtless investors who think doing investment homework means checking the stock chart. Wrong. Loving momentum is quite logical. Of all the market "anomalies," momentum is the last one standing. The January effect is long gone, small companies have been choppy, and value investors are sooo "old economy." But momentum keeps on chugging. Even Gene Fama, the high priest of the efficient-markets sect, grants that the strategy has worked, for reasons that he can’t explain.

In addition, the economic news remains very friendly to stock prices. Yes, Mr. Greenspan and others are concerned about wage inflation, overconsumption, excess borrowing, and other indicators that the expansion is growing long in the tooth. It’s their job to worry. But in truth, things look a lot like 1997 or 1998--several green lights for every yellow light. If the end is near, it is not visible even to those, like Greenspan, who squint.

So even though I’m not playing momentum stocks myself, I can--and will--defend today’s momentum buyers. Just don’t take all this talk of a new revolution too seriously, OK? The revolution has been fully discovered and fully priced. Therefore, its leaders aren’t companies to buy and hold. They’re pieces of paper to trade. At some point in the not-too-distant future, momentum will suffer the fate of all anomalies: It will collapse under the weight of its own popularity. When that occurs, be careful that the true believers, not you, end up holding the bag.

What’s Indexing Got to Do With It?
As you probably know, dull ol’ Vanguard hasn’t led the 1999-2000 performance derby. Its funds tend to have a large-cap tilt, and they have been slow to scoop up the hot new technology companies that have propelled the market. This has led many to advocate what one might call a Vanguard/Janus strategy: blending a core of cheap, steady index funds from Vanguard with somebody else’s momentum funds.

Again, no complaints here. What puzzles me is that people are framing this decision as part of the active vs. passive management debate. It is not. The reason that index fans buy actively managed momentum funds is that (a) they want to play the momentum game, and (b) there aren’t any such passively managed funds. However, (b) is not a necessity. It would be quite easy to come up with some simple rules and construct a momentum index. Perhaps this index would outperform most active momentum managers. Perhaps not. We don’t know. The point is, the current popularity of actively run momentum funds is a comment on the tastes of those who construct indexes, rather than on the nature of indexing itself.

Etc.
One more indication we are in the bull market to end all bull markets: Advertisements for Barron’s keeping popping up on the Cartoon Channel. My child is not impressed.

Forget all those stock-market indicators. The ultimate contrarian signals are issued from political commentators, who veered from Bradley to Bush to McCain with perfect hindsight. Now that Al Gore is their current favorite, he must be heading for trouble.

Not to rub salt in the wounds of all you Shaq baiters, but the Big Fella will not only walk away as league MVP, but also by the largest margin in years. You’ll be wincing when he hoists the NBA Championship trophy, too.