The Lindy Effect Can Make You a Better Investor
Broadway is home to long-running hits. And many flops. It was also home to Lindy’s Delicatessen. That was a hot spot for actors, writers and the people who make Broadway what it is for almost a 100 years.
According to legend, actors enjoying a late-night meal at Lindy’s noticed that if a Broadway show lasted for 100 performances, it had a good chance of lasting another 100 shows. This observation is known as the Lindy Effect.
Economist Nassim Nicholas Taleb popularized the idea in his book Antifragile: Things That Gain From Disorder. Taleb generalized the Lindy Effect to anything nonperishable.
A book that has been in print for several decades will probably be in print for several more decades. For instance, the Iliad has been around for thousands of years. It’s likely to be around for many more.
Some ancient technologies, like the wheel, have been around for thousands of years. They should exist for many more years.
But this doesn’t always work. Lindy’s business did close after being open for 96 years. Although a few New York delis survive that long.
I thought about the Lindy Effect as I reviewed momentum investing studies. This phenomenon reveals exactly why we want to be following momentum as traders…
Tracing the Past of Momentum Trading
One momentum study from 1993 called “Returns to Buying Winners and Selling Losers” is often — but mistakenly — considered the first study in the field. It was just the first to become widely cited.
“Relative Strength as a Criterion for Investment Selection” was published 26 years earlier, in 1967. That paper was quickly forgotten. Its results contradicted the efficient market hypothesis, which was widely accepted in the 1960s.
Traders knew about momentum even earlier. I actually spoke to the author of the 1967 paper and asked where the idea came from. He learned about it from someone in his office. That guy traded the strategy in the Great Depression, and he learned it from a floor trader in the 1910s.
The Lindy Effect tells us since momentum worked for 100 years, it’s likely to work for another 100 years.
But it gets even better. History shows it’s already worked for more than 200 years.
That study, “Two Centuries of Price Return Momentum” used data from 1801 to 2012. The authors found that the momentum effect was consistent and significant the entire time.
Studies are useful. Especially when they cover extended time frames. They prove momentum is statistically robust.
But if it’s going to work another 200 years, there must be a reason that it works.
Well, there are a few explanations for why momentum strategies often deliver exceptional results….
Why Momentum Works
Momentum strategies tend to rely on long price histories. To deliver gains over a long time frame, a stock needs to survive downturns in the market and the economy. That survival implies a high likelihood of future survival.
The fact that a stock has momentum means the price is going up. That’s important because institutional investors tend to buy stocks that are going up. Their demand helps keep the uptrend in prices intact.
Uptrends are also a reason for continued uptrends. As a stock rises, it becomes a larger part of major market indexes. Index investors then need to buy more to keep the right weighting in their portfolio.
Momentum has withstood the test of time. It’s also likely to work in the future. The Lindy Effect tells us that. We can also be confident in its future because there are reasons why it works.
This is a strategy that investors should consider following. My colleague Adam O’Dell has spent years studying momentum. Now he’s sharing his latest research on it in his new service — Infinite Momentum Alert.
Cutting through all the noise, he’s focusing on 10 of the best stocks with the highest probability of hitting gains in the next 30 days.
He’s discovered how holding a portfolio of the top 10 stocks with strong momentum, combined with other powerful metrics, could outperform the S&P 500 by 300-to-1 over the long term.
Adam has just released the first list of stocks to own over the next month for a strong chance at crushing the market. To learn how you can access this list and see his strategy, be sure to watch his presentation here.
Editor, Precision Profits
Home Prices Falling?
With mortgage rates stuck near multi-decade highs, home affordability is scraping along at its lowest levels since the mid 1980s. The latest reading of the National Association of Realtors Housing Affordability Index came in at 87.8.
To give a little context there, the index measures the degree to which a typical family can afford the monthly mortgage payments on a typical home.
A value of 100 means that a family with the median income has just enough income to qualify for a mortgage on a median-priced home. Anything above 100 means that the average family has more than enough income to qualify, assuming they’re putting down a 20% down payment.
In other words, if housing is cheap.
Any measure below 100 means that the average family can’t afford the mortgage … or that housing is expensive.
A History of Housing
The data here goes back to the early 1980s, and a funny thing happened. As mortgage rates fell throughout the ‘80s and ‘90s, the average home became more and more affordable for the average family, even as home prices rose.
This topped out around 2000, and started to fall during the housing bubble of the early and mid-2000s.
And then, as prices fell (particularly as mortgage rates plummeted following the 2008 meltdown), housing affordability just kept improving. In 2020, the Housing Affordability Index sat at 180. This means that housing was dirt cheap. Or, at least house payments based on prevailing mortgage rates was dirt cheap.
Making Homes Affordable
The total collapse in home affordability, which dropped the index from 180 to just 87, is due in part to the run-up in home prices during the COVID-19 pandemic. But more than anything, it’s due to mortgage rates going through the roof.
Mortgage rates aren’t likely to drop until long-term bond yields drop, and that’s not likely to happen until inflation falls further.
So if mortgage rates aren’t coming down, the only way to make homes affordable again is to see price declines, right?
Maybe. But I wouldn’t count on it.
Housing starts have been trending sharply lower since early 2022. New supply simply isn’t coming online fast enough to allow prices to moderate. In fact, it’s going the wrong direction and slowing at exactly the time it needs to be speeding up.
So, it seems we’re stuck.
Given the tightness in supply, we’re not likely to see meaningful improvement in home affordability any time soon.
Of course, if you already have a home, that’s not a bad thing! One positive here is that, unless something changes, we’re not likely to see any major drop in home prices!
Chief Editor, The Banyan Edge
After spending nearly 20 years developing pattern recognition software for the United States Air Force, I retired from my military career in 2005. My plan was to utilize the same pattern recognition principals I used in the military and apply them to the largest and most lucrative market in the world: the stock market.