Investing in the stock market can be a challenging task, especially when trying to identify high-growth markets and stocks with promising performance. In this article, we discuss the stark contrast between the Chinese and American stock markets over the past 15 years. Although China has experienced significant economic growth during this period, its stock market failed to generate any substantial returns. On the other hand, the S&P 500 in the United States witnessed an impressive 640% growth.
This stark difference raises a crucial question: why do stock market prices sometimes diverge from underlying growth narratives? GDP growth rates and market performance do not always align. For instance, while the U.S. market currently experiences low single-digit GDP growth, its stock market is thriving. Conversely, China enjoys high single-digit GDP growth, yet its stock market struggles to gain momentum. These divergences highlight the complex nature of stock market performance and the need for investment strategies that can identify winning markets and stocks.
Momentum investing involves identifying and investing in stocks or markets that exhibit upward momentum, while avoiding those that underperform. In this case, if the S&P 500 and the Chinese stock market were treated as stocks in a momentum strategy, the former would have consistently been included in the portfolio, while the latter would have been excluded for most of the 15-year period.
Momentum investing eliminates the need for guesswork or prediction about individual market or stock performance. It is a strategy that allows investors to ride the wave of existing momentum rather than making speculative bets. The example of the Chinese and American stock markets serves as a powerful illustration of how momentum investing can guide investors towards long-term success.
By following a momentum approach, investors can filter out underperforming stocks and focus on those with strong momentum. This is particularly relevant in markets like India’s Nifty, where several companies struggle to deliver consistent returns. When investing in broad market indices like the Nifty, investors may have to hold these underperforming stocks. However, by focusing on the momentum of the overall market, investors can ensure they remain invested in the stocks that drive the growth of the market.
The fundamental premise of momentum investing lies in selecting winners automatically based on their momentum. This strategy eliminates the need for subjective judgments, predictions, or extensive research. Rather than trying to pinpoint which market or stock will perform well, momentum investing relies on the principle that stocks with strong momentum will continue to outperform in the future.
Momentum investing is not without its risks, as markets can change quickly, and past performance is not always indicative of future results. However, by adhering to a disciplined approach and constantly monitoring the momentum of stocks and markets, investors can improve their chances of success.
If you have any questions, please write to support@weekendinvesting.com
