Despite Market Hiccups, Price Momentum Still Driving Returns

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by: James Picerno

Perhaps the world's stock markets will merely slow down rather than suffer a glaring correction. That may be overly optimistic, but looking at the total returns for regions across the globe raises the prospect that a soft landing for equities is a possibility. One reason to think that a kinder, gentler correction may be in the offing is that liquidity is still high and there's an abundance of committed investing shops looking for bargains.

The combined assets in mutual funds, ETFs and hedge funds have never been greater. Such capital may be flighty when it comes to any particular corner of the securities markets or countries. But portfolios jammed with cash looking for a home aren't going anywhere, at least not any time soon. The explosion in professional investment management in all its various guises means that there's always of hungry investors. That may prove ill-advised in time, but the trend has been decades in the making and it won't evaporate over the next week, month or even year.

When markets correct, the glut of the world's professional money managers immediately start looking for bargains. That translates in serious buying power that springs to action on a global scale that's unprecedented. Yes, it's always unclear if funds will dive in one more time whenever the next financial cyclone hits. But market hiccups in recent years suggest there's an ongoing willingness to hunt for value, relative or absolute, whenever markets take a tumble.

Eventually, one or more of the major asset classes will suffer a large and sustained bear market. But the fact that such corrections of duration and magnitude have been missing in action for so long in just about everything suggests there's still plenty of momentum behind the buying urge. The trend will play itself eventually. Ignoring that fact may prove costly to investors overdosing on optimism. For the moment, however, the analysis may explain why higher prices are so prevalent and seem to come so easily in so much of the world.

The stock markets on the planet tell the story once again in 2007. Of the 52 nations in the S&P/Citigroup Global Equity Indices database, only three (Columbia, Taiwan and Russia) post losses this year through Friday night's close in dollar terms, with the biggest decline at a modest 5.3% loss. The remaining 49 national markets in the list are up, quite often by substantial amounts. The best performing market is Peru, which has climbed nearly 50% in 2007 through April 19.

In broader terms, the gains are impressive too, as our chart below shows. The S&P/Citigroup developed world index is up 6.8% so far this year, while emerging markets have climbed 7.2%. Regionally, the Mideast and Africa index is the star regional performer, advancing nearly 16.8% year to date. The laggard is Emerging Europe.

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Meanwhile, the U.S. gain is middling, at best, relative to markets around the world. Nonetheless, the 4.8% climb for domestic stocks is nothing to sneeze at, considering that we're not even halfway through the year and the long-term performance of U.S. equities is only slightly more than 10% annualized.

There's a hefty pile of academic research suggesting that the two leading factors driving returns (for good or ill) in managed equity portfolios are price momentum (up and down) and valuations (expensive and inexpensive). Clearly, momentum remains the dominant factor of late. The general perception is that there's more gold in them 'thar hills by way of choosing securities and markets based on the expectation of higher prices, as opposed to an attractive valuations. Eventually, the other factor will return to the fore. But for now, there's been little immediate gratification born of fighting the crowd. Buying on dips has a large and growing constituency. Only when the last investor embraces momentum will it be time to sell in earnest.