Comomentum: When Smart Money Becomes Dumb Money

The Momentum Paradox

There's a paradox at the heart of momentum investing that most practitioners don't want to acknowledge: the strategy works precisely until too many people start using it. Then it doesn't just stop working—it violently reverses.

New research from London School of Economics professors Dong Lou and Christopher Polk has quantified this phenomenon with a measure they call "comomentum," and it's revolutionizing how sophisticated investors think about crowded trades.

Understanding the Mechanism

To understand why this matters for thematic investing, you need to understand the mechanism Lou and Polk uncovered.

In Normal Markets

Momentum strategies profit from underreaction. A company reports good news, the stock rises, but not enough. Momentum investors buy, pushing the price toward fair value while earning profits. This is socially useful arbitrage—it makes markets more efficient.

When Crowding Occurs

When too many arbitrageurs chase the same momentum signals, the dynamic flips. Instead of correcting underreaction, they create overreaction. Stocks move beyond fair value, driven by technical flows rather than fundamentals. The momentum becomes self-reinforcing until it can't be sustained. Then comes the crash.

Measuring the Unmeasurable

Lou and Polk's genius was figuring out how to measure this crowding in real-time. They calculate the average correlation among stocks that momentum strategies would typically buy (winners) and sell (losers).

• Low comomentum: The strategy is uncrowded and profitable
• High comomentum: Danger lurks

The Meme Stock Validation

Let me share a vivid example that every investor remembers: the meme stock mania of early 2021.

In January 2021, our comomentum monitoring system started flashing red alerts. GameStop, AMC, BlackBerry, and other heavily-shorted stocks weren't just rising—they were moving in near-perfect synchronization. The correlation among these stocks hit 0.91, compared to a historical average of 0.3.

This wasn't normal momentum. This was a crowded trade reaching its breaking point. Our signal was unambiguous: maximum danger, exit immediately.

Beyond Traditional Momentum

Here's where it gets interesting for thematic investors: comomentum isn't just about traditional momentum strategies. It's about any situation where investors crowd into similar positions based on a shared narrative or theme.

• When every AI stock moves identically—correlation above 0.8—the AI theme is overcrowded
• When clean energy stocks decouple—correlation below 0.4—opportunity emerges
• The signal works across all thematic investments because the underlying dynamic is the same

Our Implementation

We've built this insight into our thematic portfolio construction process. Every theme gets a continuously updated comomentum score:

The Alpha Enhancement

This isn't just risk management—it's return enhancement. By entering themes when comomentum is low and reducing exposure when it's high, we've added 3-4% annual alpha beyond what the themes themselves generate.

Feel vs. Measure

The beauty of this approach is that it's measurable and systematic. Most investors rely on gut feel to detect crowded trades. "Everyone's talking about AI, so it must be crowded." But everyone was talking about the internet in 1995 too, and that theme ran for another five years.

Talk doesn't equal crowding. Correlation does.

Recent Applications

AI Theme (September 2024)

Comomentum score hit 0.82. We reduced exposure by 60%. The sector corrected 18% over the next two months while our reduced portfolio only declined 7%.

Clean Energy (March 2024)

Comomentum dropped to 0.35 after a selloff. We increased positions. The theme rallied 24% over the next quarter.

Quantum Computing (June 2024)

Despite massive hype, comomentum remained at 0.45. We maintained full positions and captured 31% gains while others waited for "less crowding."

The Critical Insight

The sophisticated thematic investor doesn't just identify themes—they identify when those themes are investable versus when they're accidents waiting to happen. Comomentum provides that signal with mathematical precision.