Momentum Investing

A reader asked: “Have you done any backtesting to compare value investing versus market timing? Magic Formula Investing seems to rank #1 in value investing and Decision Moose seems to stand out for market timing. Is there any direct comparison between Magic Formula Investing vs. Decision Moose?” Keep Reading

A reader asked: “If you have some thoughts on the claims in the article ‘The Capitalism Distribution’ by Blackstar Funds, LLC, I would be most interested in hearing them.” Keep Reading

A reader requested a review of the TimingCube market timing advisory service, which relies “on the Trend Timing Model to detect major trend changes in the broad market and to issue clear, definitive Buy and Sell signals, on average three to five times per year.” The offeror provides a history of “all ‘live’ TimingCube signals since June 18, 2001.” Using this record of 36 signals, daily S&P Depository Receipts (SPY) closes adjusted for dividends over the period 6/17/01 through 12/16/09 and daily closes of the S&P 500 Index over the period 8/30/00 through 12/16/09, we find that: Keep Reading

A reader commented and requested: “I got a lot of ideas from Michael Carr’s recently published Smarter Investing in Any Economy, which focuses on momentum investing. One idea that the author demonstrated works well, and which I don’t recall having been discussed on your web site, is that one can greatly reduce drawdowns in momentum investing, with little impact to returns, by accounting for volatility when determining Relative Strength. For example, defining a low-volatility Relative Strength as the six month return divided by the standard deviation seems to give a much better risk-adjusted reward than Relative Strength alone. If you read the book some time, I’d be interesting in your views on this. The author seems very diligent in thorough, professional testing (good sample sizes, out-of-sample verification, etc).” Keep Reading

Typically, value means unexciting low-beta stocks, and momentum means exciting high-beta stocks. Does “typically” mean always? In their September 2009 paper entitled “The Changing Beta of Value and Momentum Stocks”, Andrea Au and Robert Shapiro investigate the relationships between beta and value and between beta and momentum under varying stock market conditions. Using monthly beta distributions for value (based on book-to-market ratio) and momentum (based on prior 12-month return) sorts of the Russell 3000 stocks over the period December 1978 through March 2009, they conclude that: Keep Reading

A reader asked: “Regarding ‘Combined Value-Momentum Tactical Asset Class Allocation’, have you developed any sort of screen or model that ranks value exactly as studied in the referenced paper (asset yield or earnings yield)?” Keep Reading

A reader asked: “In reviewing your various posts on momentum-based trading, I noticed that many impose a one-month delay between momentum calculation and actual trade implementation. Is the effect/rational for this strategy adjustment referenced anywhere or is this something you can comment on?” Keep Reading

A reader asked: “Have you ever looked at the work of David Vomund at ETFtradingstrategies.com?” Keep Reading

Which measure of mutual fund momentum best predicts future fund returns? In his August 2009 paper entitled “The 52-Week High, Momentum, and Predicting Mutual Fund Returns”, Travis Sapp examines the intermediate-term future performance of mutual funds ranked by: (1) nearness to the one-year high of the fund share net asset value; (2) prior six-month fund return; and, (3) fund sensitivity to stock return momentum. Using mutual fund returns for a broad sample of U.S. common stock funds and risk-adjustment data over the period 1970-2004, he concludes that: Keep Reading

A reader wondered about the value of combining momentum and downside risk avoidance for tactical asset class allocation, as follows:

“One of the methods described in The Ivy Portfolio by Mebane Faber is a simple momentum-based asset class rotation system that shifts monthly into the one, two or three highest performing asset classes based on their performance over an average of the prior 3, 6 and 12 months. Instead of using just the 3, 6 and 12 month prior returns, what if we used an asset class Ulcer Performance Index (UPI): UPI = average return over prior 3, 6 and 12 months / average Ulcer Index (UI) over prior 3, 6 and 12 months. Would this modification identify which asset classes are in low-volatility uptrends and therefore the biggest bang for the buck? Would this allow us to invest comfortably in the top two asset classes, or even the top one asset class, instead of the top three as recommended by Faber?”

Calculation of UI over a rolling interval across a long sample period is cumbersome. As a substitute for UI, we use a standard deviation of downside weekly returns over past intervals for three asset classes: S&P Depository Receipts (SPY), iShares Barclays 20+ Year Treasury Bond (TLT) and iShares Russell 2000 Index (IWM) , with historical data limited to July 2002 (by TLT). Every four weeks, we allocate funds to whichever of SPY, TLT or IWM has the highest ratio of prior return to prior downside standard deviation, or to 13-week Treasury bills (T-bills) if all three past returns are less than the T-bill yield. Using weekly adjusted closes for the asset class proxies over the period 7/31/02 through 8/21/09 (369 weeks or about 89 months), we find that: Keep Reading