The Momentum Game Is Over; The Return Of Value

“…. the basic forces that propel markets your editor believes to be momentum and value…..”

– James Picerno, “A Short Treatise For A Two-Factor World”, May 14, 2007, The Capital Spectator

“In 2007, by far the biggest driver of US stocks was momentum.  In the last couple days it’s been the worst.”

– Joseph Mezrich (subscription required), Quantitative Analyst, Nomura Securities

As James Picerno argues in his masterful “A Short Treatise For A Two-Factor World”, which is must reading, asset markets are driven by two factors, value and emotion, corresponding to two features of the human approach to life, reason and emotion.

For the most part, as in all aspects of human life, emotion and prejudice carry the day.  It’s only at turning points that reason asserts itself, at points of acute stress in the system:

Value’s power and influence, in short, are at a peak during periods of extreme excess in the market.

Momentum carried the day through the latter half of 2006 and 2007 as equity markets surged to new highs despite mounting evidence of a massive, worldwide housing and credit bubble.

But value has asserted itself of late and now seems to have converted momentum to the downside (Momentum vs Value Graphic).

The momentum game is over and those of you who have ridden the popular names, Google, Apple, Research In Motion, Commodities and Oil, to huge gains over the last few years will find that the rules of game have changed.  Just as these stocks led on the upside, they’ll lead on the downside.