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By Shannon Zimmerman | 06-10-2011 12:21 PM

Why Has Momentum Persisted?

Investors have been wary of the notion that just following a strong trend can outperform a value analysis, which is one of the reasons momentum investing still works, says Leuthold's Doug Ramsey.

Shannon Zimmerman: For Morningstar, I am Shannon Zimmerman.

I am here today with Doug Ramsey from Leuthold Weeden Capital Management.

Doug, thank you so much for being with us today.

Doug Ramsey: Thanks for having me.

Zimmerman: Doug is here with us to have a panel discussion with a couple other folks about price momentum and earnings momentum as well, which is among the strategies that Leuthold uses in a number of its funds. Doug is a portfolio manager on the Core Investment Portfolio, Asset Allocation, and then also Leuthold's Global Fund.

Doug can you talk a little bit about Leuthold's overall approach to investing and then maybe discuss how price momentum or earnings growth momentum slots into that approach?

Ramsey: We consider ourselves to be flexible investors. Our primary funds are all tactical asset allocation funds, where we've got the latitude to shift net equity exposure around fairly significantly. 30% would be our normal minimum, although we've even undercut that number in the past, near the bubble highs of '99 and 2000, and then we'll take it to 70% at the maximum. So, that's an enormous amount of flexibility relative to your average balanced fund. And then where we use momentum is in group and security selection, within the equity pieces of those portfolios.

Zimmerman: Is it primarily price momentum or is there an earnings model as well?

Ramsey: There is an earnings model as well in terms of the overall impact on the portfolio. So, I would say, the price momentum is a bigger driver.

Zimmerman: You and I have talked about before, and we'll talk about this on the panel that's upcoming, but you've done some research into comparing those two approaches. And there's a pretty close correlation between the effectiveness of price momentum and earnings momentum…

Ramsey: ... Generally, I tend to think of earnings momentum, estimate revisions, and price momentum as belonging to the broader group of success-based strategies. In other words, you would expect the trend to persist and just comparing success-based to mean-reverting, where low is good and you are expecting to come back up to some sort of mean. So, I think in terms of how those types of factors, if you will, behave over a cycle, they are very similar.

Zimmerman: I know you have a background as well in behavioral finance. Let's talk a little bit about that as among the reasons why momentum has persisted.

You look at the decades-long track record, just empirical observation, it persists, and yet it's such a simple strategy that anyone could emulate. Why hasn't it been arbitraged away?

Ramsey: It's very difficult, I think, emotionally to execute, and there is a human need to want to be able to economically rationalize something. And I almost think there is some condescension towards the idea that just following a strong trend can somehow outperform my value analysis or my fundamental analysis.

Zimmerman: Stock investment ought to be hard and complicated, right?

Ramsey: Exactly. So, I think that's a big piece of it.

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