Momentum Investing

We have updated the Market Models summary as follows:

• Extended the Earnings Forecast through the end of 2012 based on an estimate of actual earnings for the fourth quarter of 2011.
• Extended regressions/rolled projections by one month based on data available through January 2012.
• Updated backtest charts and the market valuation metrics map based on data available through January 2012.

We have updated the six-month lagged momentum asset class, sector and style ETF winners for January 2012 on the home page.

We have updated the Trading Calendar to incorporate data for January 2012.

Does momentum investing work for currencies as it does for equities? In the December 2011 version of their paper entitled “Currency Momentum Strategies”, Lukas Menkhoff, Lucio Sarno, Maik Schmeling and Andreas Schrimpf investigate momentum strategies in foreign exchange (FX) markets. FX markets are generally more liquid than equity markets, with huge transaction volumes, low trading frictions and no short-selling constraints. The study’s principal analytic approach is to rank 48 currencies monthly based on returns over the past one, three, six, nine and 12 months and use the rankings to form six eight-currency portfolios for holding intervals ranging from one to 60 months. The monthly winners (losers) are the portfolios with the highest (lowest) past returns. Using monthly FX spot and one-month forward price and bid-ask data for 48 currencies relative to the U.S. dollar as available over the period January 1976 through January 2010, they find that: More…

How sensitive is the performance of the “Simple Asset Class ETF Momentum Strategy” to selecting ranks other than winners and to choosing a momentum ranking interval other than six months? This strategy each month ranks the following eight asset class exchange-traded funds (ETF), plus cash, on past return and rotates to the strongest class:

PowerShares DB Commodity Index Tracking (DBC)
iShares MSCI Emerging Markets Index (EEM)
iShares MSCI EAFE Index (EFA)
SPDR Gold Shares (GLD)
iShares Russell 1000 Index (IWB)
iShares Russell 2000 Index (IWM)
SPDR Dow Jones REIT (RWR)
iShares Barclays 20+ Year Treasury Bond (TLT)
3-month Treasury bills (Cash)

Available data are so limited that sensitivity test results may mislead. With that reservation, we perform two robustness/sensitivity tests: (1) comparison of returns for all nine ranks of winner through loser based on a ranking interval of six months and a holding interval of one month (6-1); and, (2) comparison of winner returns for ranking intervals ranging from one to 12 months (1-1 through 12-1) and for a six-month lagged six-month ranking interval (12:7-1) per “Isolating the Decisive Momentum (Echo?)”, all with one-month holding intervals. Using monthly adjusted closing prices for the asset class proxies and the yield for Cash over the period July 2002 (or inception if not available then) through December 2011 (114 months), we find that: More…

How sensitive is the performance of “Doing Momentum with Style (ETFs)” to selecting ranks other than winners and to choosing a momentum ranking interval other than six months? This strategy each month ranks the following six style exchange-traded funds (ETF) on past return and rotates to the strongest style:

iShares Russell 1000 Value Index (IWD) – large capitalization value stocks.
iShares Russell 1000 Growth Index (IWF) – large capitalization growth stocks.
iShares Russell Midcap Value Index (IWS) – mid-capitalization value stocks.
iShares Russell Midcap Growth Index (IWP) – mid-capitalization growth stocks.
iShares Russell 2000 Value Index (IWN) – small capitalization value stocks.
iShares Russell 2000 Growth Index (IWO) – small capitalization growth stocks.

Available data are so limited that sensitivity test results may mislead. With that reservation, we perform two robustness/sensitivity tests: (1) comparison of returns for all six ranks of winner through loser based on a ranking interval of six months and a holding interval of one month (6-1); and, (2) comparison of winner returns for ranking intervals ranging from one to 12 months (1-1 through 12-1) and for a six-month lagged six-month ranking interval (12:7-1) per “Isolating the Decisive Momentum (Echo?)”, all with one-month holding intervals. Using monthly adjusted closing prices for the style ETFs and SPDR S&P 500 (SPY) over the period August 2001 through December 2011 (125 months), we find that: More…

How sensitive is the performance of the “Simple Sector ETF Momentum Strategy” to selecting ranks other than winners and to choosing a momentum ranking interval other than six months? This strategy each month ranks the following nine sectors exchange-traded funds (ETF) on past return and rotates to the strongest sector:

Materials Select Sector SPDR (XLB)
Energy Select Sector SPDR (XLE)
Financial Select Sector SPDR (XLF)
Industrial Select Sector SPDR (XLI)
Technology Select Sector SPDR (XLK)
Consumer Staples Select Sector SPDR (XLP)
Utilities Select Sector SPDR (XLU)
Health Care Select Sector SPDR (XLV)
Consumer Discretionary Select SPDR (XLY)

Available data are so limited that sensitivity test results may mislead. With that reservation, we perform two robustness/sensitivity tests: (1) comparison of returns for all nine ranks of winner through loser based on a ranking interval of six months and a holding interval of one month (6-1); and, (2) comparison of winner returns for ranking intervals ranging from one to 12 months (1-1 through 12-1) and for a six-month lagged six-month ranking interval (12:7-1) per “Isolating the Decisive Momentum (Echo?)”, all with one-month holding intervals. Using monthly adjusted closing prices for the sector ETFs and SPDR S&P 500 (SPY) over the period December 1998 through December 2011 (157 months), we find that: More…

In the brief August 2011 paper entitled “Paired-switching for Tactical Portfolio Allocation”, flagged by a subscriber, Akhilesh Maewal and Joel Bock investigate the efficiency of a simple momentum strategy applied to pairs of exchange-traded funds (ETF) with negative return correlations. Every 13 weeks (four times per year), they rank the performances of the two funds over the prior thirteen weeks and buy the fund that has the higher return. They ignore trading frictions. Using weekly adjusted closing levels of SPDR S&P 500 (SPY), iShares Barclays 20+ Year Treas Bond (TLT), iShares MSCI EAFE Index (EFA) and Vanguard Total Stock Market ETF (VTI) over the period from about October 2002 through about June 2011, they find that: More…

Does a simple momentum strategy applied to tradable asset class proxies produce attractive results? To investigate, we test a simple strategy on the following eight asset class exchange-traded funds (ETF), plus cash:

PowerShares DB Commodity Index Tracking (DBC)
iShares MSCI Emerging Markets Index (EEM)
iShares MSCI EAFE Index (EFA)
SPDR Gold Shares (GLD)
iShares Russell 1000 Index (IWB)
iShares Russell 2000 Index (IWM)
SPDR Dow Jones REIT (RWR)
iShares Barclays 20+ Year Treasury Bond (TLT)
3-month Treasury bills (Cash)

We allocate all funds at the end of each month to the asset class ETF or cash with the highest total return over the past six months (6-1). A six-month ranking period is intuitively large enough to gauge class momentum but small enough to react to changes in economic conditions that might favor one class over others. Using monthly adjusted closing prices for the asset class proxies and the yield for Cash over the period July 2002 (or inception if not available then) through December 2011 (114 months), we find that: More…

Do simple momentum trading strategies applied to major U.S. stock market sectors outperform reasonable benchmarks? To investigate, we apply three simple momentum strategies to the nine sector exchange-traded funds (ETF) defined by the Select Sector Standard & Poor’s Depository Receipts (SPDR):

Materials Select Sector SPDR (XLB)
Energy Select Sector SPDR (XLE)
Financial Select Sector SPDR (XLF)
Industrial Select Sector SPDR (XLI)
Technology Select Sector SPDR (XLK)
Consumer Staples Select Sector SPDR (XLP)
Utilities Select Sector SPDR (XLU)
Health Care Select Sector SPDR (XLV)
Consumer Discretionary Select SPDR (XLY)

The three strategies are: (1) allocate all funds at the end of each month to the sector ETF with the highest total return over the past six months (6-1); (2) allocate all funds at the end of each month to the sector ETF with the highest total return over the six months ending the prior month (6-1;1), hypothesizing that the skip-month avoids short-term reversals; and, (3) more cautiously, allocate all funds at the end of each month either to the sector ETF with the highest total return over the past six months or to cash depending on whether the S&P 500 Index is above or below its 10-month simple moving average (6-1;SMA10). A six-month ranking period is intuitively large enough to gauge sector momentum but small enough to react to changes in business conditions that might favor one sector over others. Using monthly adjusted closing prices for the sector ETFs, the S&P 500 index, 3-month Treasury bills (T-bills) and S&P Depository Receipts (SPY) over the period December 1998 through December 2011 (157 months), we find that: More…

Over the past few days, in the background, we have updated and rationalized “Simple Sector ETF Momentum Strategy” (update pending) and “Doing Momentum with Style (ETFs)” (update just published). Updated means adding data for December 2011. Rationalized means making the two analyses more similar in data processing and presentation approaches.

We have also put together, and will soon publish, a new “Simple Asset Class ETF Momentum Strategy” that extends the general methodology to a set of exchange-traded funds (ETF) plus cash that proxy for nine asset classes.

During this process, because of growing complexity, we introduced logical programming that automates identification of monthly ETF winners and loading of subsequent monthly returns. In validating this programming, we found errors in old winners data for “Doing Momentum with Style (ETFs)” that were material to findings because they occurred during high market volatility. Specifically, the errors led to incorrect conclusions that a simple momentum strategy applied to style ETFs likely outperforms both an equally weighted portfolio of style ETFs and a simple momentum strategy applied to sector ETFs. After correction of the errors in today’s update, findings are that a simple momentum strategy applied to style ETFs performs about the same as an equally weighted portfolio of style ETFs and a simple momentum strategy applied to sector ETFs. We apologize for the errors.

We found no such errors in “Simple Sector ETF Momentum Strategy”.

“Beat the Market with Hot-Anomaly Switching?” concludes that “a trader who periodically switches to the hottest known anomaly based on a rolling window of past performance may be able to beat the market. Anomalies appear to have their own kind of momentum.” Does momentum therefore work for style-based exchange-traded funds (ETF)? To investigate, we apply a simple momentum strategy to the following six ETFs that cut across market capitalization (large, medium and small) and value versus growth:

iShares Russell 1000 Value Index (IWD) – large capitalization value stocks.
iShares Russell 1000 Growth Index (IWF) – large capitalization growth stocks.
iShares Russell Midcap Value Index (IWS) – mid-capitalization value stocks.
iShares Russell Midcap Growth Index (IWP) – mid-capitalization growth stocks.
iShares Russell 2000 Value Index (IWN) – small capitalization value stocks.
iShares Russell 2000 Growth Index (IWO) – small capitalization growth stocks.

The simple (6-1) strategy allocates all funds each month to the one style ETF with the highest total return over the past six months. A six-month ranking period is intuitively large enough to gauge style momentum but small enough to react to changes in business conditions that might favor one style over others. An alternative, more cautious strategy allocates at the end of each month all funds either to the style ETF with the highest total return over the past six months or to cash depending on whether the S&P 500 Index is above or below its 10-month simple moving average (6-1;SMA10). Using monthly adjusted closing prices for the style ETFs, the S&P 500 index, 3-month Treasury bills (T-bills) and S&P Depository Receipts (SPY) over the period August 2001 through December 2011 (125 months, limited by data for IWS and IWP), we find that: More…