I’m Smarter Than You

Over recent weeks, the recovery of equity markets has left many scratching their heads. In particular, some distressed companies, such as Hertz (NYSE: HTZ) and Chesapeake Energy Corp. (NYSE: CHK), have experienced monumental gains after releases of negative news. A recent piece out of the Wall Street Journal explores how the overconfidence of investors contributes to the momentum anomaly that is found in financial markets. Momentum is the tendency for securities that have done well (or poorly) to continue to exhibit the same behaviour in the short to medium term. Momentum has proven to be a viable strategy through certain regimes, though historically the factor has been stronger during bull markets. Additionally, the authors suggest investors have an overconfidence in their own ability to forecast future returns, while discounting the abilities of others market participants. This can lead to either under or overreaction to certain financial news, especially during times of company disclosures and market value becoming increasingly detached from intrinsic value. The key takeaway of the article is that while momentum can be an effective factor to explain financial market returns, it is best used in conjunction with other factors to form a robust portfolio. A reduction in certainty in favour of humility could help to combat the overconfidence bias and assist investors in their portfolio construction.