Beyond The Headlines
Value and momentum: the tortoise and the hare
Chances are that you remember Aesop’s ancient fable about the Tortoise and the Hare. In case you need a reminder, in that tale the speedy Hare mocks the slow-moving Tortoise, who then challenges it to a race. The Hare sets a scorching pace and leaves the Tortoise far behind. Then, sure of its victory, it takes a nap, only to find out later that the Tortoise has slowly but steadily won the race! The investment terms “value” and “momentum” often remind me of the heroes of Aesop’s fable. Value investing is a steady tortoise, and momentum investing is a jumpy hare. Value investors buy cheap stocks, momentum investors buy stocks that have been going up.
As you may know, we consider ourselves contrarian value investors. We like to buy stocks when they are down, cheap, and out of favor. In the early years of my career though, I briefly shadowed a successful momentum growth investor. I witnessed how value and momentum fared during the run-up to the end of the last bull market in 2007, the tricky investment conditions in 2008-2009, and finally, the first stretch of an unconvincing bull market. It was not an easy time for either momentum or growth investing.
There is a huge timing difference between when value investors buy and when momentum investors buy. The former buy when the price is low, and the stock may be regarded with scorn. Momentum investors get interested much later in the business cycle, waiting to see signs of an established trend. Their ideal buying moment is when a stock’s price rises, all the metrics show growth and improvement, yet there’s room for momentum to endure. Everybody knows, owns, and loves the stocks that momentum buyers seek out. The usual trouble comes with short-lived trends that are challenging for momentum investors to identify and time. The very best days for these investors come in the late stages of a bull market, when trends are well-established. The experience of a momentum buyer could be compared to jumping onto a train that’s already in motion.
We at Sicart consider ourselves not only value buyers, but also growth holders. Each value stock goes through a fairly frequent and repeatable pattern. It usually starts off with a big sell-off, when the stock gets much cheaper. At that point many investors doubt it will ever recover. They may well be right, but if they are wrong, a disciplined value investor has a chance to buy a great business at a very attractive price. When this happens, it’s usually not because a value investor is much smarter or faster than anybody else, but because he or she is more patient. Eventually, the business improves, the stock starts to go up. It not only recovers, but it also starts a healthy steady ascent, which eventually attracts momentum investors. They join the party, bidding up the stock even higher. First the gap between value and price disappears, and the stock is no longer a bargain. Then the price starts to exceed the value of the business. Value investors start to get anxious, but momentum investors don’t worry as long as the price continues to rise.
When more impatient value investors start to sell, we at Sicart become growth holders. We believe we bought the stock at the right price, and now we let our winners run. That’s where I combine my value investing discipline with the lessons I learned shadowing a momentum growth investor. There is no rush to take the gains, because there is a lot more money on the table. It’s patience, again, that helps me as an investor.
There has been a lot of talk lately that value investing doesn’t work, and momentum is the way to go. This is the same song we hear every 5-10 years as bull markets mature. Buying more of the fastest-rising stocks has become the winning formula, and passively riding out the wave has performed the best.
But I believe that value investing always works. To me that means being able to compound wealth slowly and steadily over time, without exposing investors to a risk of losing it all. Of course, there are times when “value” as a style delivers lesser short-term returns than “momentum” investing or even the indices as a whole. That’s the case right now, but it shouldn’t worry us much. Remember that, as with the tortoise and the hare, the goal is to finish the race!
I also learned from my brief experience with momentum investing that it works the best, and attracts the most attention and money, when it’s about to lose its effectiveness as an investment strategy. When momentum turns, it’s not a gradual shift, it’s a drop off the cliff. Individual stocks – or the entire market — can give up the entire gain of a few years, in a swift 50% drop. For a single stock, that could happen in a matter of days. Each time these cycles occur, the latecomers to the market party believe that they will ride it to the top, get out, and wait until the dust settles. Unfortunately, that’s rarely the case. I’d dare to argue that no strategy has lost more money for stock investors than chasing momentum in the last hours of a long and tired bull market.
However, when the drop happens, and momentum investing goes out of favor, it’s a good time to behave like an investment tortoise – slow and steady, stay on your path. Pick up more cheap stocks, let them recover, and watch them become momentum stocks all over again. Aesop told the story 2,500 years ago, La Fontaine retold it 300 years ago, and we witness it in every alternation between bull and bear markets.
I’m not saying value is better than momentum as a philosophy (though you know where I stand), but I do say that there is wisdom in both. Why not be a value buyer, and growth holder? The most renowned investors of our times, Warren Buffett and Charlie Munger, are just that. They buy when the price is right, and hold stocks forever. Many of their value stocks have long since become momentum stocks. They know the temperament of the latter, hence their ample cash reserves, ready to be deployed when the momentum abruptly comes to a screeching halt, and buying opportunities arise.
As investors, we definitely feel like a trusty tortoise rather than a hasty hare these days. How do you feel? Like a tortoise or a hare?
The information provided in this article represents the opinions of Sicart Associates, LLC (“Sicart”) and is expressed as of the date hereof and is subject to change. Sicart assumes no obligation to update or otherwise revise our opinions or this article. The observations and views expressed herein may be changed by Sicart at any time without notice.
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