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Value Investing Strategy (Strategy Overview)

Allocations for August 2020 (Final)
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Momentum Investing Strategy (Strategy Overview)

Allocations for August 2020 (Final)
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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.

Simple Currency ETF Momentum Strategy

Do exchange-traded funds (ETF) that track major currencies support a relative momentum strategy? To investigate, we consider the following four ETFs:

Invesco DB US Dollar Bullish (UUP)
Invesco CurrencyShares Euro Currency (FXE)
Invesco CurrencyShares Japanese Yen (FXY)
WisdomTree Chinese Yuan Strategy (CYB)

We each month rank these ETFs based on past return over lookback intervals ranging from one to 12 months. We consider portfolios of past winners reformed monthly based on Top 1 and on equally weighted (EW) Top 2 and Top 3 ETFs. The benchmark portfolio is the equally weighted combination of all four ETFs. We present findings in formats similar to those used for the Simple Asset Class ETF Momentum Strategy and the Simple Asset Class ETF Value Strategy. Using monthly adjusted closing prices for the currency ETFs during March 2007 (when three become available) through December 2019, we find that: Keep Reading

Simple Term Structure ETF/Mutual Fund Momentum Strategy

Does a simple relative momentum strategy applied to tradable U.S. Treasury term structure proxies produce attractive results by picking the best duration for exploiting current interest rate trend? To investigate, we run short-term and long-term tests. The short-term test employs four exchange-traded funds (ETF) to represent the term structure:

SPDR Barclays 1-3 Month T-Bill (BIL)
iShares 1-3 Year Treasury Bond (SHY)
iShares Barclays 7-10 Year Treasury Bond (IEF)
iShares Barclays 20+ Year Treasury Bond (TLT)

The second test employs three Vanguard mutual funds to represent the term structure:

Vanguard Short-Term Treasury Fund (VFISX)
Vanguard Intermediate-Term Treasury Fund (VFITX)
Vanguard Long-Term Treasury Fund (VUSTX)

For each test, we allocate all funds at the end of each month to the fund with the highest total return over a specified ranking (lookback) interval, ranging from one month to 12 months. To accommodate the longest lookback interval, portfolio formation commences 12 months after the start of the sample. We focus on compound annual growth rate (CAGR) and maximum drawdown (MaxDD) as key performance metrics. Using monthly dividend-adjusted closing prices for BIL since May 2007, for SHY, IEF and TLT since July 2002 and for VFISX, VFITX and VUSTX since October 1991, all through December 2019, we find that: Keep Reading

Doing Momentum with Style (ETFs)

“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.

We test a simple Top 1 strategy that allocates all funds each month to the one style ETF with the highest total return over a set momentum ranking (lookback) interval. We focus on the baseline ranking interval from the “Simple Asset Class ETF Momentum Strategy (SACEMS)”, but test sensitivity of findings to ranking intervals ranging from one to 12 months. As benchmarks, we consider an equally weighted and monthly rebalanced combination of all six style ETFs (EW All), and buying and holding S&P Depository Receipts (SPY). As an enhancement we consider holding the Top 1 style ETF (3-month U.S. Treasury bills, T-bills) when the S&P 500 Index is above (below) its 10-month simple moving average at the end of the prior month (Top 1:SMA10), with a benchmark substituting SPY for Top 1 (SPY:SMA10). We consider the performance metrics used for SACEMS. Using monthly dividend-adjusted closing prices for the six style ETFs and SPY, monthly levels of the S&P 500 index and monthly yields for T-bills during August 2001 (limited by IWS and IWP) through December 2019, we find that:

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Simple Sector ETF Momentum Strategy Update/Extension

“Simple Sector ETF Momentum Strategy” investigates performances of simple momentum trading strategies for the following nine sector exchange-traded funds (ETF) executed with 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)

Here, we update the principal strategy and extend it by adding equally weighted combinations of the top two and top three sector ETFs, along with corresponding robustness tests and benchmarks. We present findings in formats similar to those used for the Simple Asset Class ETF Momentum Strategy and the Simple Asset Class ETF Value Strategy. Using monthly dividend-adjusted closing prices for the sector ETFs and SPDR S&P 500 (SPY) and 3-month U.S. Treasury bill (T-bill) yields since December 1998, and S&P 500 Index levels since September 1998, all through December 2019, we find that: Keep Reading

Reducing Downside Risk of Trend Following Strategies

How can investors suppress the downside of trend following strategies? In their July 2019 paper entitled “Protecting the Downside of Trend When It Is Not Your Friend”, flagged by a subscriber, Kun Yan, Edward Qian and Bryan Belton test ways to reduce downside risk of simple trend following strategies without upside sacrifice. To do so, they: (1) add an entry/exit breakout rule to a past return signal to filter out assets that are not clearly trending; and, (2) apply risk parity weights to assets, accounting for both their volatilities and correlations of their different trends. Specifically, they each month:

  • Enter a long (short) position in an asset only if the sign of its past 12-month return is positive (negative), and the latest price is above (below) its recent n-day minimum (maximum). Baseline value for n is 200.
  • Exit a long (short) position in an asset only if the latest price trades below (above) its recent n/2-day minimum (maximum), or the 12-month past return goes negative (positive).
  • Assign weights to assets that equalize respective risk contributions to the portfolio based on both asset volatility and correlation structure, wherein covariances among assets adapt to whether an asset is trending up or down. They calculate covariances based on monthly returns from an expanding (inception-to-date) window with baseline 2-year half-life exponential decay.
  • Impose a 10% annual portfolio volatility target.

Their benchmark is a simpler strategy that uses only past 12-month return for trend signals and inverse volatility weighting with annual volatility target 40% for each asset. Their asset universe consists of 66 futures/forwards. They roll futures to next nearest contracts on the first day of the expiration month. They calculate returns to currency forwards using spot exchange rates adjusted for carry. Using daily prices for 23 commodity futures, 13 equity index futures, 11 government bond futures and 19 developed and emerging markets currency forwards as available during August 1959 through December 2017, they find that: Keep Reading

Handling Reversals in Price Trend Direction

What is the best way to balance crash protection and false alarms for intrinsic, also called absolute or time series, momentum strategies that are long (short) an asset when its return over a specified past interval is positive (negative)? In their November 2019 paper entitled “Momentum Turning Points”, Ashish Garg, Christian Goulding, Campbell Harvey and Michele Mazzoleni investigate blending slow and fast intrinsic momentum signals with various weights on each (adding to one) to identify the best way to handle reversals in trend direction. They specify a slow (fast) signal as that derived from past 12-month (1-month) excess return. They define four market states: (1) Bull (slow and fast signals both non-negative); (2) Correction (slow signal non-negative and fast signal negative); (3) Bear (slow and fast signals both negative); and, (4) Rebound (slow signal negative and fast signal non-negative). They first consider static weights in increments of 25% for slow and fast signals. They then consider a dynamic strategy with slow and fast signal weights that differ for Correction and Rebound states as identified with monthly data. They test usefulness of the dynamic strategy by optimizing weights with historical returns and then evaluating performance of these weights out-of-sample. While focusing on the U.S. stock market, they test robustness of findings across other developed country equity markets. Using monthly excess returns for the U.S. value-weighted stock market since July 1926 and for 10 other developed stock markets since February 1980, all through December 2018, they find that:

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Retail Trading Drives Stock Momentum?

Is retail trading a reliable driver of U.S. stock momentum? In his November 2019 paper entitled “Retail Trading and Momentum Profitability”, Douglas Chung investigates interactions across stocks between current proportion of retail trading and future momentum returns. Specifically, for each month and for each of two recent stock samples, he:

  • Sorts stocks into fifths (quintiles) by current proportion of retail trading.
  • Within each proportion-of-retail-trading quintile:
    • Sorts stocks into sub-quintiles by return from 12 months ago to one month ago.
    • Calculates average next-month returns for an equal-weighted momentum portfolio that is long (short) the sub-quintile of stocks with the highest (lowest) past returns. He also considers other portfolio weighting schemes.
    • Measures alphas of these returns based on various widely accepted single-factor and multi-factor models of stock returns.

He next tests whether proportion of retail trading relates to a gambling motive (lottery trading) by constructing a stock lottery index from inverse of stock price, idiosyncratic volatility, idiosyncratic skewness and recent maximum daily return. In other words, he examines whether the lottery index value for a stock is a proxy for its proportion of retail trading. Using daily data for all NYSE retail orders during March 2004 through December 2014, for small NYSE trades of U.S. common stocks (a proxy for retail trading) during January 1993 through July 2000 and for lottery index inputs during 1940 through 2016, he finds that: Keep Reading

Intrinsic Momentum or SMA for Avoiding Crashes?

A subscriber suggested comparing intrinsic momentum (IM), also called absolute momentum and time series momentum, to simple moving average (SMA) as alternative signals for equity market entry and exit. To investigate across a wide variety of economic and market conditions, we measure the long run performances of entry and exit signals from IMs over past intervals of one to 12 months (IM1 through IM12) and SMAs ranging from 2 to 12 months (SMA2 through SMA12). We consider two cases for IM signals and one case for SMA signals, as applied to the S&P 500 Index as a proxy for the stock market and the 3-month U.S. Treasury bill (T-bill) as a proxy for cash (the risk-free rate). The three rule types are therefore:

  1. IMs Case 1 – in stocks (cash) when past index return is positive (negative).
  2. IMs Case 2 – in stocks (cash) when average monthly past index return is above (below) average monthly T-bill yield over the same interval.
  3. SMAs – in stocks (cash) when the index is above (below) the SMA.

We estimate S&P 500 Index monthly total returns using monthly dividend yield calculated from Shiller data. This estimation does not affect index timing signals. We focus on net compound annual growth rate (CAGR), maximum drawdown (MaxDD) and annual Sharpe ratio as key performance metrics, with baseline stocks-cash switching frictions 0.2%. We use buying and holding the S&P 500 Index (B&H) as a benchmark. Using monthly closes of the S&P 500 Index during December 1927 through November 2019 (92 years), and contemporaneous monthly index dividend and T-bill yields, we find that:

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Factor Portfolio Longs vs. Shorts

Do both the long and short sides of portfolios used to quantify widely accepted equity factors benefit investors? In their November 2019 paper entitled “When Equity Factors Drop Their Shorts”, David Blitz, Guido Baltussen and Pim van Vliet decompose and analyze gross performances of long and short sides of U.S. value, momentum, profitability, investment and low-volatility equity factor portfolios. The employ 2×3 portfolios, segmenting first by market capitalization into halves and then by selected factor variables into thirds. The extreme third with the higher (lower) expected return constitutes the long (short) side of a factor portfolio. When looking at just the long (short) side of factor portfolios, they hedge market beta via a short (long) position in liquid derivatives on a broad market index. Using monthly returns for the specified 2×3 portfolios during July 1963 through December 2018, they find that:

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SACEVS-SACEMS for Value-Momentum Diversification

Are the “Simple Asset Class ETF Value Strategy” (SACEVS) and the “Simple Asset Class ETF Momentum Strategy” (SACEMS) mutually diversifying. To check, we look at three equal-weighted (50-50) combinations of the two strategies, rebalanced monthly:

  1. SACEVS Best Value paired with SACEMS Top 1 (aggressive value and aggressive momentum).
  2. SACEVS Best Value paired with SACEMS Equally Weighted (EW) Top 3 (aggressive value and diversified momentum).
  3. SACEVS Weighted paired with SACEMS EW Top 3 (diversified value and diversified momentum).

We also test sensitivity of results to deviating from equal SACEVS-SACEMS weights. Using monthly gross returns for SACEVS and SACEMS portfolios since January 2003 for the first strategy and since June 2006 for the latter two, all through November 2019, we find that: Keep Reading

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