Mr Miller calculates that if you had taken the 50 best performing stocks over the 3 years ending December 31st 2006 and taken them as your portfolio for this year, you would have earned a return double that achieved by the S&P 500. In other words, what goes up did not come down but kept on rising.
That is not the traditional pattern of financial markets. Momentum has been a successful strategy but only in the short term (say six to twelve months). Over the longer term, stocks tend to revert to the mean, as attractive companies eventually become overvalued and struggling companies become cheap. This time, the winners have kept on winning, particularly in commodities, industrials and emerging markets. As Mr Miller points out, these all thrive on global reflation and global growth.
Mr Miller has essentially lost by betting on the reversion to the mean, assuming that beaten-up stocks in the financial and consumer sectors would rebound. Given his record, he may well prove to be right in the end, just as they those who forecast the tech bust were eventually vindicated.
Monday, November 12, 2007
Momentum vs. Mean Reversion
The Economist reports on the fall of Bill Miller and his Legg Mason Value Trust which is trailing the S&P500 by 7%.
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What a bunch of scare tactic crap. Comparing a Value manager to the S&P is pointless, since he only plays on the value side and the S&P accounts for 90% of the market. That's the economist overstating his role to prove their point (quite apart from their arbitrary time selection). Picking a small window is as pointless to a manager as it should be to an investor. Do you view your car's value based on its first year?
ReplyDeleteMomentum may be successful for betting on sectors, but a fund manager's job is to rifle shoot the winners out of a sector, It is more likely that he has a few rotten apples.
Is Momentum the new reversion to the mean? Too trendy. Momentum is people buying airlines in the summer and sell them in the winter. But, they hold onto Southwest because it actually makes money. Now, imagine that someone attacked NYC and oil went to 100 a barrel. Would you short the whole sector? Yes. Would that indicate the implosion of the industry? Southwest, Airtran, Virgin Atlantic and several others would disgree since they've made as much as Delta et all have lost. What does it prove? Delta has reverted to its mean since it got out of bankruptcy (it just took longer). Their market cap is still 4.8 Billion due to acquisitions-just as much as stock price...proving that the market cap doesn't dry up as quickly as the money spreads when consolidation is taken into account.