I’ve used this quote to discount the validity of a single observation to explain much of anything. That observation is true. Yet the real quote, attributed to Stanford researcher Ray Wolfinger, is the following:“The plural of anecdote is not data”
Every data point has a story and sometimes that story can illuminate a larger truth. I think the anecdote of Tesla’s recent stock surge this year gives us some insight into the Momentum Factor, namely that stocks like Tesla that have already surged in price are emotionally impossible to own for those of us not day trading on Robinhood. And for good reason: they can fall out of favor fast! The potential for these massive price corrections and the psychological toil of owning them helps explain the return premium associated with the Momentum Factor. Tesla’s recent stock volatility and the emotions it triggers not only makes it a worthy poster child for momentum stocks but also provides some insight into the differences across both momentum factors and momentum funds. And dare I add when looking at the price action of similar stocks on November 9th, it is a warning on what may yet still be on the horizon.“the plural of anecdote is data”. Ray Wolfinger
November 9th: A Unique Day for Momentum Investors
The traditional academic “momentum” moniker most simply applies to stocks that have performed the best over the past year. These stocks over various time periods and across markets, both in and out of sample, have exhibited excess risk-adjusted returns as well documented on this blog (here is an example) as well as many others(1). Equally well documented is the ability of momentum stocks to drop like a stone. In fact, on November 9th of this year, one of the sharpest price reversals for these stocks in the last couple of decades occurred. Yet the event passed largely unnoticed by the general public (outside of some by the #fintwit community and modest coverage in the Wall Street Journal).
The results are hypothetical results and are NOT an indicator of future results and do NOT represent returns that any investor actually attained. Indexes are unmanaged, do not reflect management or trading fees, and one cannot invest directly in an index.

The results are hypothetical results and are NOT an indicator of future results and do NOT represent returns that any investor actually attained. Indexes are unmanaged, do not reflect management or trading fees, and one cannot invest directly in an index.
Differences Across Momentum Factors and Funds
And what about the large performance differences across the factors for this date? What first appears to be minor differences in both how and when to calculate the factor has major repercussions for returns. The Momentum Factor attempts to neutralize swings in the market by going long these momentum stocks and short out-of-favor stocks that have done poorly. But different quants calculate that factor differently. Ken French of Dartmouth sorts daily to calculate the Fama-French Daily Momentum Factor and combines both big company and small company portfolios to go long and short momentum. Bloomberg uses an implicit factor model using multivariate cross-sectional regression analysis designed to zero out exposure to other factors, including the market. Dow Jones sorts stocks based on 12 months returns within various sectors in attempt to minimize industry bets. French uses market value weights. To avoid idiosyncratic risk, Bloomberg uses the square root of market value when determining weights. Dow Jones uses equal weighting and rebalances quarterly. Even momentum definitions can differ. Although momentum enjoys considerable consensus on what it means, namely 6 to 12 months of relative strong performance with an adjustment for well documented short term (up to a month) reversals, this also can lead to differences in returns. French-Fama’s factor uses returns starting 251 days back (roughly 12 months) and stopping 21 days back (roughly 1 month) to avoid short-term reversals. Bloomberg goes back 54 weeks and stops 2 weeks back. Dow Jones just goes back 52 weeks with no adjustment for short-term reversals. Definitions aside, the differences in returns of the long-short measurements of the Momentum Factor also translates into differences in returns to long-only Exchange Traded Funds (i.e., ETFs) and mutual funds trying to capture the momentum strategy’s excess returns. As shown in the table below, on November 9th most, but not all, of the listed funds dropped with the factor indexes while the U.S. Market, as measured by Vanguard’s Total Stock Market ETF <VTI> was up 1.25%.
Tesla and its Ilk
Note in my table, I include the returns of ARK Innovation ETF <ARKK> as well as Tesla and “Jon’s Bubble” stock portfolio. Let me admit the sad back story about why I did. Back on September 9th I proudly wrote to my clients that Tesla’s then drop in price may reflect a long-overdue correction. I quote:In my article on “Price” from earlier this year, I shared this graph constructed by Morgan Stanley analyst Adam Jonas as a humble admission that the then-current price of Tesla may prove to be way off in hindsight but, like all stock prices, was likely the best guess of value at the time. The future movement of stocks are just too hard to predict. Even after dropping 33% since the end of the month, Tesla’s stock price is still at a split-adjusted $1,651, up nearly 400% from the date of the article and over 3X’s his bull case.



The results are hypothetical results and are NOT an indicator of future results and do NOT represent returns that any investor actually attained. Indexes are unmanaged, do not reflect management or trading fees, and one cannot invest directly in an index.
Momentum: An Efficiently Priced Risk Factor or a Behavioral Mispricing?
Again, I want to use Tesla as an antidote to help dissect the long- and short-term success of momentum strategies. The Momentum Factor I believe acts as both efficient compensation for risk and as a tool to profit from common mispricing (gasp, market inefficiencies) due to well-established behavioral heuristics. A better understanding of this dynamic keeps me invested in the strategy even though I believe another correction is coming. My disgust with Tesla’s continued escalation solidifies my awareness that my biases to shy away from these types of stocks are deep and the pain of owning them, even via an ETF, is real. Although I’m still climbing, the initial steps out of this deep-rooted bias against momentum were also arduous. I’m a product of Gene Fama’s Financial Theory course, TA’d at one time by both Cliff Asness of AQR fame, a firm built with a momentum foundation, and Wes Gray of Alpha Architect, the author of The Book on momentum investing who also hosts this blog. At the time, 1992, Fama was co-chairing Asness’s dissertation on momentum’s unexplained persistence to generate excess risk-adjusted returns(10). He undoubtedly thus wasn’t naïve to the factor. By then, the empirical evidence supporting the outperformance of those stocks that have performed the best in the last 12 months (not including the first month) had been published by Narasimhan Jedadeesh (11). Yet, it didn’t make our reading list. In fact, Jegadeesh (1990) was only barely mentioned in Fama’s 1991 seminal survey of attacks on market efficiency, Efficient Capital Markets: II, which concludes, “…the new research on the predictability of long‐horizon stock returns from past returns is high on drama but short on precision.” It seems Fama had his biases, too. But like the factor return itself, the evidence for employing momentum strategies kept compounding. Corey Hoffstein of Newfound Research provides a nice summary of the path of acceptance through both time periods and markets here. Eventually, even Fama and his prolific counterpart Ken French (2017) (12) “somewhat reluctantly” accepted momentum as a worthy factor for explaining the cross-section of stock returns. Although trained to recognized that supposed patterns in stock prices were illusions to those weaker minds seeking order in the reality of randomness (13), eventually (with the help of Wes/Jack…thank you!), I, too, succumbed to the evidence. But it was hard, especially when looking under the hood to see the stocks these momentum ETFs owned. But general acceptance of the data hasn’t translated into an acceptance of the theory behind the data. Modern Portfolio Theory has evolved in its broader efforts to explain differences in returns across stocks. From the vantage point of an efficient market assumption, Bill Sharpe constructed a world where investors look only for compensation for risk tied to their current portfolios (e.g., CAPM). Robert Merton’s world saw investors willing to hedge their current and future consumption with a variety of factors (e.g., Intertemporal CAPM or ICAPM). And Lu Zhang more recently argued for an investment world where differences in expected return are driven by firms’ decisions to invest (Investment CAPM) instead of investors’ desire to hedge. Momentum’s tendency to crash like it did on November 9th and other periods favor viewing the excess returns generated by the Momentum Factor as fair compensation to disruptions in future consumption a la’ ICAPM. But my experience indicates it is also compensation for my stomach aches and sleepless nights. I’ll wait for someone else to build that fact into a workable pricing model. Investing in a fund that owns stocks like Tesla let alone owning the stocks outright isn’t easy but why doesn’t the knowledge that these companies provide excess returns act as a tonic? Or why not alleviate the side-effects of momentum investing with Pepto Bismol and sleeping pills? In other words, why do the premium and my stomach aches persist? Behavioral heuristics also seems to have a role. Anchoring is the tendency of mere mortals to place too much emphasis on the first piece of information we receive. Although I had an unbiased view of Tesla at the start of the year, I saw the analyst Adam Jonas give the stock an upside for 2020 of $500 as reasonable. No surprise that when Tesla reached a split-adjusted $2,000, I was incredulous. We also place a greater value on avoiding a big loss over capturing a big gain. I can’t imagine buying any of my bubble stocks, including Tesla, right now (14). Our tendency towards loss aversion makes us overly fear the second half of the idiom “pigs get fat and hogs get slaughtered” so much that we never fatten our portfolios. But hogs many of these stocks become and a subsection of the investor community (again, see Robinhood) seem morbidly obese. “One more thin mint?” The momentum factor also seems to capture the tendency to believe that success is based on skill versus luck and breeds overconfidence and rationalizations like claiming Tesla could be the next Amazon. Yes, Amazon’s similar valuation was once scoffed at, too. But rightfully so even with hindsight. Amazon shares dropped 94% between December 1999 and September 2001 even though its sales nearly tripled in the ensuing two years. It wasn’t until 2007 and sales had increased over 600% before it regained its stock price from the end of 1999.Conclusion
In short, Tesla’s stock performance makes me squirm. Back in September I let my clients know that I thought the valuation was crazy. But TSLA doesn’t care what I think and doubled yet again. It takes all the strength than I can muster to invest in stocks like Tesla that have already skyrocketed in price, and even then I outsource the task to momentum ETFs. It also takes a higher expected return to attract investors. So far this year, many, but certainly not all, momentum funds exceeded those high expectations. The devil is in the details on why some versus others have performed well, but the results show up in the holdings: those weighted most toward stocks of companies experience product innovation and growth even in the face of COVID-19 have smoked the market. Will these stocks likely tumble back to earth in a flame at some point. History tells us yes. And history tells us that November 9th was an almost unprecedented extreme rotation out of momentum and major moves are typically clustered. Three antidotes certainly don’t translate into data, but given that the other large reversals occurred coming out of The Great Depression, The Internet Bubble and The Great Financial Crisis when the momentum factor suffered some of its largest drawdowns does make one pause. Having already feasted plenty from the trough, let’s hope momentum factors and funds will rotate out of the current crop of market darlings this time and into the new hot stocks that I seem equally mentally programmed to want to avoid.References