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Market View

Momentum is a powerful factor, with greed and fear often causing stock prices to diverge from fundamentals. An acute awareness of the impact of these forces is key. 

As discussed in previous Market Views, high-growth stocks are a special asset class, historically providing investors a distinct source of excess return. Yet, accompanying the great potential of high-growth stocks has often been greater risk. As described by Lord Abbett portfolio managers Tom O’Halloran and Vernon Bice in a recent commentary on their approach to growth investing, “the allure of a ‘multi-bagger’ growth stock gives rise to greed, while the prospect of a harrowing decline instills fear.”

These two emotions, greed and fear, in conjunction skew the share prices of high-growth stocks, frequently causing them to deviate from their fundamentals. For investors, ignoring these very human elements affecting high-growth stocks may be a mistake, as the behavioral biases inherent in this asset class can present tremendous opportunity if played correctly.  

One notable way that greed and fear manifest themselves in high-growth stocks is through momentum—the phenomenon by which prior price action is predictive of future prices. The existence of momentum has been explored in numerous empirical studies, and, as O’Halloran and Bice note, “some of this evidence suggests that the momentum premium has been a part of markets for as long as there have been markets.”1 Chart 1 illustrates the momentum anomaly over the period 1927–2015.

 

Chart 1. The Momentum Premium Has Existed for Decades
“Winners” and “losers” versus the U.S. market,* 1927–2015
  

Source: Tuck School of Business at Dartmouth.  The data are from professor Kenneth French’s data library at Dartmouth, and stretch from 1927–2015. The momentum portfolios are reconstituted monthly and the other research portfolios are reconstituted annually. We reconstruct the full history of returns each month when we update the portfolios. (Historical returns can change, for example, if Dartmouth’s Center for Research in Security Prices revises its database.) The portfolios include all NYSE, AMEX, and NASDAQ firms.
* The “market” is defined by the widely cited analysis of proprietary Fama/French benchmark portfolios. To find winners and losers, the database for momentum stocks has been sorted by decile. “Winners” represent an average of the top 50% of decile returns and “losers” represent the average return of the bottom 50% of decile returns.  Hypothetical portfolios are unmanaged, are not investable, and returns are for illustrative purposes only, and do not reflect any management fees, transaction costs or expenses. The chart provided is the most recent data available. If more recent data were available, the analysis may be significantly different. Statements concerning financial market trends are based on current market conditions, which will fluctuate. There is no guarantee that markets will perform in a similar manner under similar conditions in the future. This document contains forward-looking statements about various economic trends and strategies. You are cautioned that such forward-looking statements are subject to significant business, economic and competitive uncertainties and actual results could be materially different. There are no guarantees associated with any forecast and the opinions stated here are subject to change at any time.

 

As illustrated above, momentum can have either a powerful positive or negative influence on the returns of stocks, with those stocks exhibiting positive price momentum outperforming the wider market by 3% on an annualized basis, while those exhibiting negative momentum lagging by more than 4%. Given the prevalence of greed and fear that affect growth stocks, it is no surprise, to us, that momentum is particularly evident in high-growth stocks. For this reason, investors in this space may be wise to seek out active managers who are particularly adept at navigating the opportunities and risks that momentum provides.

Momentum, however, does not just come in one flavor. In fact, according to O’Halloran and Bice, “momentum has two dimensions: absolute and relative momentum,” the difference being that “absolute momentum compares a stock’s price performance with its past performance, while relative momentum compares its price performance with other stocks.” While both absolute and relative momentum have proven to enhance returns, an approach that combines the two dimensions has, historically, proven to exceed the performance of both in terms of nominal and risk-adjusted return. (See Table 1.)

 

Table 1. Combining Absolute and Relative Momentum Historically Has Been Optimal 
Composite portfolios,2 1974–2011

 
Source: Gary Antonacci, “Risk Premia Harvesting Through Dual Momentum,” Portfolio Management Associates, 2012. 
The information shown is for illustrative purposes only and  does not represent any specific portfolio managed by Lord Abbett or any particular investment. Past performance is not a reliable indicator or a guarantee of future results.

 

Again, we find that momentum, if properly applied, may significantly enhance returns—the operative word being “properly.” What we mean by that is that because stock picking is both an absolute and relative endeavor, harnessing the potential of momentum requires an understanding of both absolute and relative momentum, with a flexible approach that can incorporate both.

In sum, U.S. high-growth stocks are a unique asset class with the potential to provide distinct outperformance, albeit with greater risk, due to the  greed and fear that affect the prices of these stocks. Because of these behavioral biases, a thorough understanding of momentum, in addition to deep fundamental company insights, can potentially help managers capture the significant potential of high-growth stocks.

 

1 Cliff Asness, Andrea Frazzini, Ronen Israel, and Tobias Moskowitz, “Fact, Fiction and Momentum Investing,” The Journal of Portfolio Management, September 23, 2014.
2 Composite equities used in the Antonacci study used the MSCI U.S., MSCI EAFE, and MSCI ACWI ex U.S. indexes. These are free float-adjusted market-capitalization weightings of large- and mid-cap stocks. The MSCI EAFE Europe, Australia and Far East Index includes 22 major developed market countries, excluding the United States and Canada. The MSCI ACWI ex U.S., i.e., MSCI All Country World Index ex U.S., includes 23 developed market countries and 21 emerging market countries. MSCI ACWI ex U.S. data begin in January 1988. Antonacci team created a composite data series called EAFE+, which had been comprised of the MSCI EAFE Index up until December 1987, and the MSCI ACWI ex US after its formation in December 1987.

 

The Sharpe ratio was developed by Nobel laureate William F. Sharpe as a measure of risk-adjusted performance. It is calculated by taking an asset class’s (or portfolio’s) excess return above the risk-free rate and dividing it by the standard deviation of its returns. The greater the Sharpe ratio, the better the risk-adjusted performance has been.

Standard deviation is a measure of the dispersion of a set of data from its mean. The more spread apart the data, the higher the deviation.

Indexes are unmanaged, do not reflect the deduction of fees or expenses, and are not available for direct investment.

IMPORTANT INFORMATION

Risks to Consider: Keep in mind that all investments carry a certain amount of risk including possible loss of the principal amount invested. No investment strategy, including diversification and asset allocation, guarantees a profit or protects against a loss. Stock markets and investments in individual stocks are volatile and can decline significantly in response to issuer, market, economic, industry, political, regulatory, geopolitical, and other conditions. While growth stocks are subject to the daily ups and downs of the stock market, their long-term potential as well as their volatility can be substantial.  Investments in smaller companies may involve greater risks than those in larger, more well known companies.

This commentary may contain assumptions that are “forward-looking statements,” which are based on certain assumptions of future events. Actual events are difficult to predict and may differ from those assumed. There can be no assurance that forward-looking statements will materialize or that actual returns or results will not be materially different from those described here.

Indexes are unmanaged, do not reflect the deduction of fees or expenses, and are not available for direct investment.

No investing strategy can overcome all market volatility or guarantee future results.

Statements concerning financial market trends are based on current market conditions, which will fluctuate. There is no guarantee that markets will perform in a similar manner under similar conditions in the future.

The information provided is not directed at any investor or category of investors and is provided solely as general information about Lord Abbett’s products and services and to otherwise provide general investment education. None of the information provided should be regarded as a suggestion to engage in or refrain from any investment-related course of action as neither Lord Abbett nor its affiliates are undertaking to provide impartial investment advice, act as an impartial adviser, or give advice in a fiduciary capacity. If you are an individual retirement investor, contact your financial advisor or other fiduciary about whether any given investment idea, strategy, product or service may be appropriate for your circumstances.

The opinions in Market View are as of the date of publication, are subject to change based on subsequent developments, and may not reflect the views of the firm as a whole. The material is not intended to be relied upon as a forecast, research, or investment advice, is not a recommendation or offer to buy or sell any securities or to adopt any investment strategy, and is not intended to predict or depict the performance of any investment. Readers should not assume that investments in companies, securities, sectors, and/or markets described were or will be profitable. Investing involves risk, including possible loss of principal. This document is prepared based on the information Lord Abbett deems reliable; however, Lord Abbett does not warrant the accuracy and completeness of the information. Investors should consult with a financial advisor prior to making an investment decision.

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