Value investors buy cheap stocks and sell expensive stocks, hoping their cheap stocks will get more expensive and expensive stocks will get cheaper. In essence, Value strategies are trades that bet on the convergence of valuation towards the mean. Value works best when the cross-sectional dispersion of valuation narrows from a high level, and vice versa.
-Chun Wang, co-portfolio manager, Leuthold Weeden Capital Management
- We are seeing a strong and clear Poor-Value/Strong-Momentum pattern emerge, which could indicate a looming market top. While QE3 could disrupt it, the pattern looks unmistakable so far.
- This is telling us to be cautious, for while the present circumstances favor Momentum, a switch to a more Value-oriented strategy may be necessary should the market roll over.
Value and Momentum strategies have long been the bread and butter of quants. These strategies are simple to construct and work better than most other quantitative strategies over time. In our last look at this topic in October 2010, we highlighted the following relationship between Value and Momentum strategy performance* around market tops and bottoms:
- At market tops, Value tends to perform poorly while Momentum performs well.
- At market bottoms, Value performs well while Momentum suffers.
As the chart below shows, Value and Momentum have exhibited this pattern at all three previ- ous major market tops (boxes with down arrows) and bottoms (boxes with up arrows).