Friday, May 12, 2006

Dumb, Dumber, Dumbest

In the interests of economy I will sacrifice eloquence for speed today in my attempt to highlight one of the more interesting characteristics of recent Japanese price action: From the point of view of return relative to the average security, the only thing worse than being a high-momentum stock is being a low momentum stock.

This is say that "High-momentum" stocks - that pool of securities outperforming all others in terms of price return during the prior formation periods - has done very badly indeed since the beginning of the calendar year. This is true across all formation periods - short and long alike. With negative returns running from between 12 and 20 relative percent.

there are few fundamental factors or pockets that have done worse than that and many of your favorite Japanese long-only and hedge funds will be reflecting this fact, since the only way pedestrian stocks get to graduate to the elite high-momentum gentleman's club is by your not-so-selfless agent/portfolio manager buying them, and buying them and buying- most likely at higher and yet-higher prices. Now before you excoriate (or excommunicate) them, let it be said that the adept may have gotten out, and their gains on the way in may exceed their losses on the way out. Jeff Vinik is a fine an example of such an adept player.

But what is fascinating is that perhaps the only thing that has done worse than extremely buying extremely high momentum (in any formation period), is buying extremely low momentum, again in any every time frame where negative returns have ranged from -20 to -30 relative percent since the beginning of the calendar year. This is even true for short-term horizons which have historically been fertile places to look for "a bounce", "bottom fish", or "catch the falling knife" with some moderate success.

So what is one to make of it since, every financial advisor is jolly-well smitten with Japan? Well "momentum" is conceptually vacant. Today's high or low momentum is different than last month's high or low momentum and they may reflect highly contrasting phenomena. Some may be "justifiably high or low, and some may not. At the moment, I would suggest that the immediate future will remain difficult for BOTH high and low momentum. BOTH are expensive, with the current Class of 2006 high momentum as highly valued as the ignominious class of 2000 (and we know what happened to them!). But low momentum, while often a nice place to scour for tomorrows' undervalued darling has a decidedly pasty fundamental pallour. And while there may be some hidden gems, buying underperformance or low momentum as a matter of course is likely to remain unrewarding. Finally, for the ever-popular players of the "good-stock/bad-stock" game, the risk is likely to be elevated relative to the pedestrian expected returns and so one is likely to see their favorite Japanese quality-biased long-short manager underperform the more adept and forward-thinking one. We are likely to be entering a phase where avoiding the wrong stocks (proverbial potholes and torpedoes) yields far more relative return than selecting the right stocks.

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