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Momentum Investing

Do financial market prices reliably exhibit momentum? If so, why, and how can traders best exploit it? These blog entries relate to momentum investing/trading.

Equity Factor Time Series Momentum

In their July 2019 paper entitled “Momentum-Managed Equity Factors”, Volker Flögel, Christian Schlag and Claudia Zunft test exploitation of positive first-order autocorrelation (time series, absolute or intrinsic momentum) in monthly excess returns of seven equity factor portfolios:

  1. Market (MKT).
  2. Size – small minus big market capitalizations (SMB).
  3. Value – high minus low book-to-market ratios (HML).
  4. Momentum – winners minus losers (WML)
  5. Investment – conservative minus aggressive (CMA).
  6. Operating profitability – robust minus weak (RMW).
  7. Volatility – stable minus volatile (SMV).

For factors 2-7, monthly returns derive from portfolios that are long (short) the value-weighted fifth of stocks with the highest (lowest) expected returns. In general, factor momentum timing means each month scaling investment in a factor from 0 to 1 according its how high its last-month excess return is relative to an inception-to-date window of past levels. They consider also two variations that smooth the simple timing signal to suppress the incremental trading that it drives. In assessing costs of this incremental trading, they assume (based on other papers) that realistic one-way trading frictions are in the range 0.1% to 0.5%. Using monthly data for a broad sample of U.S. common stocks during July 1963 through November 2014, they find that: Keep Reading

Simple Debt Class Mutual Fund Momentum Strategy

A subscriber requested confirmation of the performance of a simple momentum strategy that each month selects the best performing debt mutual fund based on total return over the past three months. To investigate, we test a simple strategy on the following 12 mutual funds (those with the longest histories from a proposed list of 14 funds):

T. Rowe Price New Income (PRCIX)
Thrivent Income A (LUBIX)
Vanguard GNMA Securities (VFIIX)
T. Rowe Price High-Yield Bonds (PRHYX)
T. Rowe Price Tax-Free High Yield Bonds (PRFHX)
Vanguard Long-Term Treasury Bonds (VUSTX)
T. Rowe Price International Bonds (RPIBX)
Fidelity Convertible Securities (FCVSX)
PIMCO Short-Term A (PSHAX)
Fidelity New Markets Income (FNMIX)
Eaton Vance Government Obligations C (ECGOX)
Vanguard Long-Term Bond Index (VBLTX)

We consider a strategy that allocates funds at the end of each month based on total returns over a specified ranking (lookback) interval to the Top 1, equally weighted (EW) Top 2, EW Top 3, EW Top 4 or EW Top 5 funds. We determine the first winners in November 1988 so that at least nine funds are available for lookback interval sensitivity testing. As a benchmark, we use the equally weighted and monthly rebalanced combination of all available funds (EW All). Using monthly dividend-adjusted closing prices for the 12 mutual funds from inceptions through June 2019, we find that: Keep Reading

SACEMS, SACEVS and Trading Calendar Updates

We have updated monthly allocations and performance data for the Simple Asset Class ETF Momentum Strategy (SACEMS) and the Simple Asset Class ETF Value Strategy (SACEVS). We have also updated performance data for the Combined Value-Momentum Strategy.

We have updated the Trading Calendar to incorporate data for July 2019.

Preliminary SACEMS and SACEVS Allocation Updates

The home page, Simple Asset Class ETF Momentum Strategy (SACEMS) and Simple Asset Class ETF Value Strategy (SACEVS) now show preliminary positions for August 2019. For SACEMS, the top two positions are unlikely to change by the close, but the contest between third and fourth places is very close and markets may be volatile this afternoon. For SACEVS, allocations are unlikely to change.

SACEMS vs. Luck

How lucky would a asset class picker with no skill have to be to match the performance of the Simple Asset Class Momentum Strategy (SACEMS), which each month picks winners from a set of eight exchange-traded funds (ETF) plus cash based on total returns over a specified lookback interval. To investigate, we run 1,000 trials of a “strategy” that each month allocates funds to one, the equally weighted two or the equally weighted three of these nine assets picked at random. We focus on gross compound annual growth rate (CAGR) and gross maximum drawdown (MaxDD) as key performance statistics. Using monthly total (dividend-adjusted) returns and for the specified assets during February 2006 (limited by DBC) through June 2019, we find that:

Keep Reading

Combining RSI Range and RSI Momentum for Stocks

Some traders use a Relative Strength Index (RSI) range to identify trend and RSI extremes to signal turning points. How long should they require that RSI remain in range, and how often should they require that RSI recapture a momentum threshold? In his December 2018 paper entitled “Finding Consistent Trends with Strong Momentum – RSI for Trend-Following and Momentum Strategies”, Arthur Hill systematically tests the predictive power of 14-day RSI range and momentum signals on S&P 500 stocks. Specifically, he tests each of the following five signals over lookback intervals of 25, 50, 75, 100 and 125 trading days:

  1. RSI Bull Range: RSI between 40 and 100.
  2. RSI Bear Range: RSI between 0 and 60.
  3. RSI Bull Momentum: highest high value of RSI greater than 70.
  4. RSI Bear Momentum: lowest low value of RSI less than 30.
  5. RSI Bull Range-Momentum: combination of 1 and 3.

For example, 25-day RSI Bull Range signals buy at the close when 14-day RSI has been between 40 and 100 over the last 25 trading days and sell at the open when it next crosses below 40. His performance metrics are gross Success Rate (frequency of positive/negative returns after buy/sell signals) and gross Profit/Loss Ratio (average gain of successful trades divided by average loss of failed trades). Using daily prices for historical S&P 500 stocks during July 1998 through June 2018, he finds that:

Keep Reading

SACEMS Applied to Mutual Funds

A subscriber inquired whether a longer test of the “Simple Asset Class ETF Momentum Strategy” (SACEMS) is feasible using mutual funds rather than exchange-traded funds (ETF) as asset class proxies. To investigate, we consider the following set of mutual funds (partly adapted from the paper summarized in “Asset Allocation Combining Momentum, Volatility, Correlation and Crash Protection”):

  1. Vanguard Total Stock Market Index Investor Shares (VTSMX)
  2. Vanguard Small Capitalization Index Investor Shares  (NAESX)
  3. Fidelity Diversified International (FDIVX)
  4. Vanguard Long-Term Treasury Investor Shares (VUSTX)
  5. Fidelity New Markets Income Fund (FNMIX)
  6. Vanguard REIT Index Investor Shares (VGSIX)
  7. First Eagle Gold A (SGGDX)
  8. Oppenheimer Commodity Strategy Total Return A (QRAAX) until discontinuation in mid-2016, and PIMCO CommoditiesPLUS Strategy (PCPSX) thereafter
  9. 3-month U.S. Treasury bills (Cash)

We rank mutual funds based on total (dividend-adjusted) returns over past (lookback) intervals of one to 12 months. We consider portfolios of past mutual fund winners based on Top 1 and on equally weighted (EW) Top 2 through Top 5. We consider as benchmarks: an equally weighted portfolio of all mutual funds, rebalanced monthly (EW All); buying and holding VTSMX; and, holding VTSMX when the S&P 500 Index is above its 10-month simple moving average (SMA10) and Cash when the index is below its SMA10 (VTSMX:SMA10). Using monthly dividend-adjusted closing prices for the above mutual funds and the yield for Cash during March 1997 through June 2019, we find that: Keep Reading

Adjust the SACEMS Asset Universe?

The Simple Asset Class ETF Momentum Strategy (SACEMS) each month picks winners based on total return over a specified ranking (lookback) interval from the following eight asset class exchange-traded funds (ETF), plus cash:

  1. PowerShares DB Commodity Index Tracking (DBC)
  2. iShares MSCI Emerging Markets Index (EEM)
  3. iShares MSCI EAFE Index (EFA)
  4. SPDR Gold Shares (GLD)
  5. iShares Russell 2000 Index (IWM)
  6. SPDR S&P 500 (SPY)
  7. iShares Barclays 20+ Year Treasury Bond (TLT)
  8. Vanguard REIT ETF (VNQ)
  9. 3-month Treasury bills (Cash)

Based on findings in “SACEMS Portfolio-Asset Addition Testing”, a subscriber proposed adding iShares JPMorgan Emerging Market Bond Fund (EMB) to this set. To investigate, we revisit relevant analyses and conduct robustness tests, with focus on the equal-weighted (EW) Top 3 SACEMS portfolio. Using monthly dividend-adjusted closing prices for asset class proxies and the yield for Cash during February 2006 (when all ETFs in the baseline universe are first available) through June 2019, we find that: Keep Reading

Factor Premium Reliability and Timing

How reliable and variable are the most widely accepted long-short factor premiums across asset classes? Can investors time factor premium? In their June 2019 paper entitled “Factor Premia and Factor Timing: A Century of Evidence”, Antti Ilmanen, Ronen Israel, Tobias Moskowitz, Ashwin Thapar and Franklin Wang examine multi-class robustness of and variation in four prominent factor premiums:

  1. Value – book-to-market ratio for individual stocks; value-weighted aggregate cyclically-adjusted price-to-earnings ratio (P/E10) for stock indexes; 10-year real yield for bonds; deviation from purchasing power parity for currencies; and, negative 5-year change in spot price for commodities.
  2. Momentum – past excess (relative to cash) return from 13 months ago to one month ago.
  3. Carry – front-month futures-to-spot ratio for equity indexes since 1990 and excess dividend yield before 1990; difference in short-term interest rates for currencies; 10-year minus 3-month yields for bonds; and, percentage difference in prices between the nearest and next-nearest contracts for commodities.
  4. Defensive – for equity indexes and bonds, betas from 36-month rolling regressions of asset returns versus equal-weighted returns of all countries; and, no defensive strategies for currencies and commodities because market returns are difficult to define.

They each month rank each asset (with a 1-month lag for conservative execution) on each factor and form a portfolio that is long (short) assets with the highest (lowest) expected returns, weighted according to zero-sum rank. When combining factor portfolios across factors or asset classes, they weight them by inverse portfolio standard deviation of returns over the past 36 months. To assess both overfitting and market adaptation, they split each factor sample into pre-discovery subperiod, original discovery subperiod and post-publication subperiod. They consider factor premium interactions with economic variables (business cycles, growth and interest rates), political risk, volatility, downside risk, tail risk, crashes, market liquidity and investment sentiment. Finally, they test factor timing strategies based on 12 timing signals based on 19 methodologies across six asset classes and four factors. Using data as available from as far back as February 1877 for 43 country equity indexes, 26 government bonds, 44 exchange rates and 40 commodities, all through 2017, they find that: Keep Reading

Optimal Long-Short Stock Momentum Strategies in European Markets

Is there a common optimal set of ranking (lookback) interval, holding interval, weighting scheme and skip-month rule for long-short stock momentum strategies across European country markets? In her May 2019 paper entitled “Are Momentum Strategies Profitable? Recent Evidence from European Markets”, Anastasia Slabchenko identifies optimal parameter sets from 576 long-short stock momentum strategy variations in each of France, Germany, Greece, Italy, Netherlands, Portugal, Spain, Sweden and UK. Variations derive from:

  • Past return ranking (lookback) intervals of 1 to 12 months.
  • Holding intervals of 1 to 12 months.
  • Value weighted (VW) or equal-weighted (EW) momentum portfolios.
  • Skip-month or no skip-month between ranking and holding intervals.

She defines the optimal variation as that generating the highest average gross monthly return. Using end-of-month closing prices for stock samples from each country, excluding financial stocks and stocks priced less than one euro, during December 1989 through January 2018, she finds that: Keep Reading

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