Momentum Investing: Do So at Your Own Peril

| About: Feihe International, (ADY)

I am a huge fan of Investors Business Daily and expect that many of you are as well. For those not familiar with the paper run by the legendary William O'Neil (Daily Graphs), it is very technically oriented compared to other business dailies (i.e. the WSJ). While I really appreciate the work that they do regarding overall market direction, the most interesting benefit I derive is idea generation for small-cap names. For IBD, it's all about momentum. In rising markets, momentum works, but in sideways or down markets, it can fail miserably.

IBD publishes an index of the top 100 companies in its universe in terms of earnings and price momentum, the IBD 100. Here is the official definition from their website:

IBD® 100 Index

The IBD 100, which runs every Monday in the IBD newspaper and can be found in the Screen Center on, is a computer-generated ranking of leading companies trading in the U.S. Rankings are based on a combination of each company's recent profit growth record; IBD's Composite Rating, which includes key measures such as return on equity, sales growth and profit margins; and relative price performance in the last 12 months. "Quarters of rising sponsorship" counts quarters in a row in which more mutual funds have purchased a company's shares than have sold shares. A company's inclusion in the list should not be viewed as a recommendation. Many are newer, smaller and highly volatile companies that require further research due to their speculative nature.

The performance, perhaps not surprisingly, has been absolutely horrible this year. With the S&P 500 and the Russell 2000 both hugging the flatline, the IBD 100 was down 11% YTD as of 7/13 and is down almost 52% over the past year. While I haven't done a scientific study of what's going on precisely, Monday's implosion of one of its 100 members, American Dairy (NYSE:ADY) offers some insight (click on chart to enlarge):


I view the dismal performance of this index over the past year and especially as it continues more recently as a sign that the overall market is starved for real growth opportunities. A company that seems to have traction attracts momentum investors but succumbs to the pressures of the overall economy, leading investors to head for the exits. The cycle of jump in, pile on, jump off seems to be dogging the index and the overall market.

So, as long as the IBD 100 continues to lag, I will be very cautious about chasing momentum and continue my strategy of buying weakness and selling strength (works very well in a sideways market).

Disclosure: No position

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