Lands' End's Precipitous Decline Fails to Cool Momentum Investing

When a glacier moves across a continent, it acts as a sort of conveyor belt, drawing earth and rock toward its leading edge. Even when the ice stops advancing, the conveyor action continues, sending till to the glacier's terminal edge. When the ice retreats, what's left is a moraine -- a sort of ramp that ends, where the glacier ended, with a drop-off.

If you're having any trouble visualizing what that looks like, a Lands' End (LE Quote) chart over the past few months should give you a pretty good idea.

It's Landed Daily stock chart of Lands' End

Of course the run-up and fall in Lands' End was anything but glacial. The stock started to generate some real buzz in August, when the catalog retailer posted a blowout second quarter. Management had turned the company around. They were gravitating away from a catalog model to an Internet one. Suddenly the stock had more than just traction -- it had velocity. You couldn't afford not to be in this one. Pretty soon, Lands' End stock was nearly double what it had been the day before it released earnings.

And then early this month the company said that sales might decline in the fourth quarter, and that was that.

The thing that made Lands' End go higher -- momentum investing -- looks like it is very much back in vogue. Stocks with strong earnings growth, and, more importantly, steady gains in price, have exploded to levels that make Graham and Dodd fundamentalists wince.

"Investment decisions are being made based on past performance," says Rich Bernstein, chief quantitative strategist at Merrill Lynch. "I don't think there are many true fundamental investors around these days.

As evidence, Bernstein notes that there "are some very big stocks that have been Nifty Fifties that have somehow unnerved the market and then got slammed" -- he won't name any, but Tyco (TYC Quote), which has fallen hard on (apparently unfounded) accounting concerns, comes to mind. If people were basing their investment decisions on fundamentals rather than momentum, says Bernstein, "they would have picked up these problems. Or they would have figured they were insignificant and just kept going."

Nor does this seem like a retail phenomenon, a K-Tel-esque (KTEL Quote) dot-com mania that big money ignores.

"Real money is in there playing," says Seth Tobias, a manager at Circle T Partners, a New York hedge fund. "It's real institutional money that's driving the prices. "How else can you explain the move the Nasdaq has had if it's not been momentum?"

In fact, the institutional participation in momentum favorites like Qualcomm (QCOM Quote) has made these fat times for your more agile retail investor. Says one trader, "I was talking to a daytrader today who I respect a lot, and he's saying it's never been as easy to make money. He's coming in and buying stocks and making money on it, just based on the mo."

While institutions shifting money into momentum stocks likely has something to do with managers chasing performance, it may also have something to do with a shift in the way people are investing in mutual funds.

In the past year, according to research from J.P. Morgan, investing in tech sector funds has steadily gained and recent data show investors are putting more money there than they are in S&P 500 index funds. And there's been a huge acceleration in flows into growth funds, where momentum-style investing is most prevalent. Meanwhile, investors have been taking money out of value funds.

"Your typical mutual fund investor is chasing performance rather than looking for value," says Doug Cliggott, equity strategist at J.P. Morgan. "If there's anything new and different, it's that that trading mentality has trickled down to the mutual fund investor."

Still, Cliggott wouldn't put the movement toward momentum-style investing "in the mania mode." Given the expectations the market has for the Internet and other technologies, it's hard to say that what's going on with some of these stocks is completely wrongheaded. But he worries that no sooner is a new story stock out there than investors have driven it to excess. And the downside of momentum is that investors pile out just as quickly when the story goes wrong.

That's how the story ended the last time around, in 1997, when momentum favorites like Cascade and Ascend (ASND Quote) -- to say nothing of Boston Chicken -- faltered. Funds that favored the style, like the growth funds run by PBHG, went from being wunderkinds to poster children.

The (PBHGX Quote)PBHG Growth fund has added 38% in the last 13 weeks.

Qualcomm is up 1,290% this year. In history, no other S&P 500 stock has ever come close to matching that performance.

Moraines are sometimes confused with tumuli. Someone will point out the window at a hill and exclaim, "Look! A burial mound!" Usually, they're wrong. But on occasion a burial mound is exactly what it turns out to be.