# 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.

**February 14, 2017** - Momentum Investing

Are there profitable intraday stock price momentum and/or reversal strategies? In his January 2017 paper entitled “Intra-Day Momentum”, Oleg Komarov examines the profitability of intraday times series (intrinsic or absolute) and cross-sectional stock price momentum and reversal strategies. Time series strategies involve predicting the behavior of a stock based on its own past return. Cross-sectional strategies involve predicting the behaviors of equally weighted groups of stocks sorted into tenths (deciles) based on their respective past returns. Specifically, he segments the trading day into half-hours and overnight and then examines whether returns for past half-hours predict returns for future half-hours, focusing empirically on whether: (1) returns during 9:30-12:00 predict returns during 15:30-1600; and, (2) returns during 9:30-13:00 predict returns during 13:30-15:30. He conducts purely statistical tests and tests based on trading strategies. He concludes with consideration of overnight returns. Using cleaned data for a broad sample of U.S. common stocks (excluding microcaps) during January 1993 through May 2010, *he finds that:* Keep Reading

**February 3, 2017** - Equity Premium, Momentum Investing, Size Effect, Value Premium, Volatility Effects

Does suppressing unrelated risks from stock factor portfolios improve performance? In their January 2017 paper entitled “Diversify and Purify Factor Premiums in Equity Markets”, Raul Leote de Carvalho, Lu Xiao, François Soupé and Patrick Dugnolle investigate how to improve the capture of four types of stock factor premiums: value (12 measures); quality (16 measures); low-risk (two measures); and, momentum (10 measures). They standardize the different factor measurement scales based on respective medians and standard deviations, and they discard outliers. Their baseline factors portfolios employ constant leverage (CL) by each month taking 100% long (100% short) positions in stocks with factor values associated with the highest (lowest) expected returns. They strip unrelated risks from baseline portfolios by:

- SN – imposing sector neutrality by segregating stocks into 10 sectors before ranking them for assignment to long and short sides of the factor portfolio.
- CV – replacing constant leverage by each month weighting each stock in the portfolio to target a specified volatility based on its actual volatility over the past three years.
- HB – hedging the market beta of the portfolio each month based on market betas of individual stocks calculated over the past three years by taking positions in the capitalization-weighted market portfolio and cash.
- HS – hedging the size beta of the portfolio each month based on size betas of individual stocks calculated over the past three years by taking positions in the equal-weighted market portfolio and the capitalization-weighted market portfolio.

They examine effects of combining measures within factor types, combining types of factors and excluding short sides of factor portfolios. They also look at U.S., Europe and Japan separately. Their portfolio performance metric is the information ratio, annualized average return divided by annualized standard deviation of returns. Using data for stocks in the MSCI World Index since January 1997, in the S&P 500 Index since January 1990, in the STOXX Europe 600 Index since January 1992 and in the Japan Topix 500 Index since August 1993, all through November 2016, *they find that:* Keep Reading

**February 1, 2017** - Fundamental Valuation, Momentum Investing

Are trend in stock fundamentals and stock price momentum mutually reinforcing return predictors? In their January 2017 paper entitled “Dual Momentum”, Dashan Huang, Huacheng Zhang and Guofu Zhou combine a measure of fundamentals trend and past return to form a U.S. stock portfolio designed to exploit the powers of both to select outperforming stocks. To construct their measure of fundamentals trend, they each month:

- For each stock, collect the last eight quarters of seven variables: return on equity; return on assets; earnings per share; accrual-based operating profit to equity; cash-based operating profit to assets; gross profit to assets; and, net payout ratio.
- For each stock, calculate four moving averages for each fundamental variable over the last 1, 2, 4 and 8 quarters (for a total of 28 moving averages per stock).
- Across all stocks, relate next-month excess stock return to the most recent 28 fundamentals moving averages via multiple regression to obtain 28 fundamentals trend betas.
- For each fundamentals beta for each stock, calculate an expected beta as the average of the last 12 monthly betas.
- For each stock, calculate a fundamentals-implied return (FIR) by applying the 28 expected betas to the most recently available 28 fundamentals moving averages.

They then each month rank stocks into value-weighted fifths (quintiles) based on FIR. Separately, they each month rank the same stocks into value-weighted quintiles based on conventional price momentum (cumulative return from 12 months ago to one month ago). Using quarterly fundamentals and monthly returns for a broad sample of U.S. stocks during January 1973 through September 2015, *they find that:* Keep Reading

**January 25, 2017** - Bonds, Equity Premium, Momentum Investing, Strategic Allocation

“Cross-asset Class Intrinsic Momentum” summarizes research finding that past country stock index (government bond index) returns relate positively (positively) to future country stock market index returns and negatively (positively) to future country government bond index returns. Is this finding useful for specifying a simple strategy using exchange-traded fund (ETF) proxies for the U.S. stock market and U.S. government bonds? To investigate we test the following five strategies:

- Buy and hold.
- TSMOM Long Only – Each month, hold the asset (cash) if its own 12-month past return is positive (negative).
- TSMOM Long or Short – Each month, hold (short) the asset if its own 12-month past return is positive (negative).
- XTSMOM Long Only – Each month hold stocks if 12-month past returns for stocks and government bonds are both positive, and otherwise hold cash. Each month hold bonds if 12-month past returns are negative for stocks and positive for government bonds, and otherwise hold cash.
- XTSMOM L-S-N (Long, Short or Neutral) – Each month hold (short) stocks if 12-month past returns for both are positive (negative), and otherwise hold cash. Each month hold (short) bonds if 12-month past returns are negative (positive) for stocks and positive (negative) for bonds, and otherwise hold cash.

We use SPDR S&P 500 (SPY) and iShares 7-10 Year Treasury Bond (IEF) as proxies for the U.S. stock market and U.S. government bonds. We use the 3-month U.S. Treasury bill (T-bill) yield as the return on cash. We apply the five strategies separately to SPY and IEF, and to an equally weighted, monthly rebalanced combination of the two for a total of 15 scenarios. Using monthly total returns for SPY and IEF and monthly T-bill yield during July 2002 (inception of IEF) through December 2016, *we find that:* Keep Reading

**January 24, 2017** - Bonds, Equity Premium, Momentum Investing, Strategic Allocation

Are stock and bond markets mutually reinforcing with respect to time series (intrinsic or absolute return) momentum? In their December 2016 paper entitled “Cross-Asset Signals and Time Series Momentum”, Aleksi Pitkajarvi, Matti Suominen and Lauri Vaittinen examine a strategy that times each of country stock and government bond (constant 5-year maturity) indexes based on past returns for both. Specifically:

- For stocks, they each month take a long (short) position in a country stock index if past returns for both the country stock and government bond indexes are positive (negative). If past stock and bond index returns have different signs, they take no position.
- For bonds, they each month take a long (short) position in a country government bond index if past return for bonds is positive (negative) and past return for stocks is negative (positive). If past stock and bond index returns have the same sign, they take no position.

They call this strategy cross-asset time series momentum (XTSMOM). For initial strategy tests, they consider past return measurement (lookback) and holding intervals of 1, 3, 6, 9, 12, 24, 36 or 48 months. For holding intervals longer than one month, they average monthly returns for overlapping positions. For most analyses, they focus on lookback interval 12 months and holding interval 1 month. For a given lookback and holding interval combination, they form a diversified XTSMOM portfolio by averaging all positions for all countries. They measure excess returns relative to one-month U.S. Treasury bills. They employ the MSCI World Index and the Barclays Capital Aggregate Bond Index as benchmarks. Using monthly stock and government bond total return indexes for 20 developed countries as available during January 1980 through December 2015, *they find that:* Keep Reading

**January 19, 2017** - Economic Indicators, Momentum Investing

Do supply chain (trade network) dynamics explain intermediate-term momentum in industry stock returns? In their December 2016 paper entitled “Feedback Loops in Industry Trade Networks and the Term Structure of Momentum Profits”, Ali Sharifkhani and Mikhail Simutin examine whether industry trading network activities create feedback that induces intermediate-term autocorrelation (echo) in associated stock returns. They apply graph theory to quantify supply-demand relationships within industry trade networks and strength of feedback loops that connect each of 49 industries to itself. They then relate network feedback strength to intermediate-term momentum (industry return from 12 months ago to seven months ago) and short-term momentum (industry return from six months ago to two months ago) for each industry as follows:

- Each month, sort the 49 industries into thirds (terciles) by current trade network feedback strength.
- Calculate the value-weighted average return of stocks within each industry.
- Within each feedback strength tercile, form a hedge portfolio that is long (short) the equal-weighted fifth, or quintile, of industries with the highest (lowest) past returns over each of the two specified momentum measurement intervals.
- Calculate average next-month return for each feedback strength-momentum double-sorted hedge portfolio.

Using industry input-output network trade data as issued (partly every five years and partly annual) and monthly industry component stock returns/capitalizations for 49 U.S. industries since 1972, and related analyst coverage data since 1984, all through December 2014, *they find that:* Keep Reading

**January 13, 2017** - Bonds, Momentum Investing

Does the credit premium, measured by the difference in returns between U.S. corporate bonds and duration-matched U.S. Treasuries, exhibit momentum? In his December 2016 paper entitled “Momentum in the Cross-Section of Corporate Bond Returns”, Jeroen van Zundert tests for momentum of the volatility-adjusted credit premium among U.S. corporate bonds via the following methodology:

- Acquire the monthly total credit premium of each corporate bond as the difference in total (coupon-reinvested) returns between the bond and a duration-matched U.S. Treasury instrument.
- For each bond, divide cumulative total credit premium over the last six months by standard deviation of monthly credit premiums over the last 12 months (something like a Sharpe ratio).
- After inserting a skip-month, sort all bonds on this metric into tenths (decile portfolios), with each bond weighted by the inverse of its volatility.
- Hold each portfolio for six months, computing an overall monthly return as the average for portfolios formed within the last six months.
- Calculate volatility-adjusted credit premium momentum as the gross difference in performance between the top (winner) and bottom (loser) decile portfolios.

To estimate portfolio alphas, he adjusts for six factors (equity market, equity size, equity value, equity momentum, bond term and default risk). In robustness tests, he considers past return measurement and holding intervals of one, three, nine and 12 months. Using total credit premiums, trading volumes and characteristics for a broad sample of U.S. investment grade and high yield corporate bonds during January 1994 through December 2015, *he finds that:* Keep Reading

**December 14, 2016** - Momentum Investing, Volatility Effects

Does a simple volatility-based risk management approach substantially enhance performance of a Betting-Against-Beta (BAB) strategy (long stocks with low market beta and short stocks with high market beta)? In their November 2016 paper entitled “Managing the Risk of the ‘Betting-Against-Beta’ Anomaly: Does It Pay to Bet Against Beta?”, Pedro Barroso and Paulo Maio examine a BAB risk management strategy that each month weights assets by a volatility target (12% annualized) divided by daily realized strategy volatility over the previous 21 trading days. For comparison, they apply this risk management approach also to other factor strategies based on their respective daily returns. Using daily and monthly BAB returns from AQR and momentum and factor model returns from Kenneth French covering a broad sample of U.S. stocks during July 1963 through December 2015, *they find that:* Keep Reading

**December 12, 2016** - Bonds, Momentum Investing, Technical Trading

Is there pervasive yield momentum among U.S. corporate bonds? In their November 2016 paper entitled “Is Momentum Spanned Over Corporate Bonds of Different Ratings?”, Hai Lin, Chunchi Wu and Guofu Zhou investigate whether momentum exists in all segments of the U.S. corporate bond market. Their approach to momentum measurement is unconventional, involving cross-sectional regression of bond returns on multiple simple moving averages (SMA) of bond yields. They call their result “trend momentum” to distinguish it from conventional momentum based on simple past return. Specifically, they each month:

- Calculate yield SMAs over the last 1, 3, 6, 12, 24, 36, 48 and 60 months for each bond.
- Regress returns for all bonds on respective prior-month yield SMAs to generate correlations (betas) between returns and past yield SMAs, thereby dynamically determining relative importance of yield SMA measurement intervals.
- Calculate expected (for next month) yield SMA betas as average calculated betas over the past 12 months.
- Estimate expected return (for next month) for each bond based on current yield SMAs and expected yield SMA betas.
- Rank bonds based on expected returns into fifths (quintiles) or tenths (deciles).
- Calculate gross trend momentum factor return as the difference in average (equal-weighted) actual returns between quintiles/deciles with the highest and lowest expected returns.

Using yields, returns, ratings and other characteristics for a broad sample of U.S. corporate bonds during January 1973 through September 2015, *they find that:* Keep Reading

**October 17, 2016** - Momentum Investing, Volatility Effects

Does adjusting leverage based on lagged strategy volatility protect an industry momentum strategy from crashes? In their September 2016 paper entitled “Risk-Managed Industry Momentum and Momentum Crashes”, Klaus Grobys, Joni Ruotsalainen and Janne Aijo investigate the profitability of risk-managed industry momentum strategies. Their asset universe consists of the 49 Fama-French value-weighted industry portfolios. They focus on a conventional momentum strategy that each month takes equally weighted long positions in past winners (top eight industries) and short positions in past losers (bottom eight industries) based on cumulative returns from 12 months ago to one month ago (12-2). They also analyze 6-2 and 12-7 variations to determine whether more recent or older past returns drive results. For risk management, they forecast next-month momentum strategy volatility based on past strategy volatility calculated based on daily returns over the past one, three or six months. They apply the volatility forecasts to determine the portfolio leverage required to target constant 12% annualized volatility. Using monthly and daily returns for the 49 industries during July 1926 through September 2014, *they find that:* Keep Reading