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Momentum Investing Strategy (Strategy Overview)

Allocations for February 2023 (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.

Combining Defensive-in-May and Sector Momentum

In response to “Combining Defensive-in-May and Sector Reversion”, a subscriber requested testing of a strategy combining seasonal effects (cyclical sectors during November through April and defensive sectors during May through October) and sector momentum. Cyclical and defensive choices are:

At the end of each October, the strategy buys the one cyclical fund with the highest return over some past interval (betting on momentum). At the end of each April, the strategy sells the cyclic fund and buys the one defensive fund with the highest return over the past interval (again, betting on momentum). For convenience, we use a 6-month lookback interval to rank funds. We use buy-and-hold SPDR S&P 500 (SPY) as a benchmark. We focus on semiannual return statistics, along with compound annual growth rates (CAGR) and maximum drawdowns (MaxDD). Using semiannual dividend-adjusted prices for the selected funds during October 2006 (limited by availability of VIG) through October 2021 (defining the first and last available semiannual intervals), we find that: Keep Reading

Combining Defensive-in-May and Sector Reversion

Inspired by “The iM Seasonal ETF Switching Strategy”, a subscriber requested testing of a strategy combining seasonal effects (cyclical sectors during November through April and defensive sectors during May through October) and sector reversion. Cyclical and defensive choices are:

At the end of each October, the strategy buys the one cyclical fund with the lowest return over some past interval (betting on reversion). At the end of each April, the strategy sells the cyclic fund and buys the one defensive fund with the lowest return over the past interval (again, betting on reversion). For convenience, we use a 6-month lookback interval to rank funds. We use buy-and-hold SPDR S&P 500 (SPY) as a benchmark. We focus on semiannual return statistics, along with compound annual growth rates (CAGR) and maximum drawdowns (MaxDD). Using semiannual dividend-adjusted prices for the selected funds during October 2006 (limited by availability of VIG) through October 2021 (defining the first and last available semiannual intervals), we find that: Keep Reading

Stock Factor Anomalies in Pre-1926 U.S. Data

Do widely accepted equity factor premiums exist in data older than generally employed in academic studies? In their November 2021 paper entitled “The Cross-Section of Stock Returns before 1926 (And Beyond)”, Guido Baltussen, Bart van Vliet and Pim van Vliet look for some of the most widely accepted factor premiums in a newly assembled sample of U.S. stocks spanning January 1866 through December 1926 (61 years of additional and independent data). Specifically, they look at: size as measured by market capitalization; value as measured by dividend yield (strongly associated with earnings during the sample period); stock price momentum from 12 months ago to one month ago; short-term (1-month) return reversal; and, risk as measured by market beta. They use only those stocks which trade frequently and apply liquidity/data quality filters. To measure factor premiums, they each month for each factor:

  • Regress next-month stock return versus stock factor value and compute slopes of the relationship.
  • Reform a value-weighted hedge portfolio that is long (short) stocks with high (low) expected returns based on factor values to measure: (1) average factor portfolio gross return; and, (2) gross factor (CAPM) alphas and betas based on regression of factor portfolio excess return versus market excess return.

They further investigate economic explanations of factor premiums and test machine learning methods found successful with recent data. Using monthly prices, dividends and market capitalizations for 1,488 stocks in the new database, they 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 specified 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 SPDR S&P 500 (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 employ 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 October 2021, we find that:

Keep Reading

More International Equity Market Granularity for SACEMS?

A subscriber asked whether more granularity in international equity choices for the “Simple Asset Class ETF Momentum Strategy” (SACEMS), such as considered by Decision Moose, would improve performance. To investigate, we augment/replace international developed and emerging equity market exchange-traded funds (ETF) such that the universe of assets becomes:

  • SPDR S&P 500 (SPY)
  • iShares Russell 2000 Index (IWM)
  • iShares Europe (IEV)
  • iShares MSCI Japan (EWJ)
  • iShares MSCI Pacific ex Japan (EPP)
  • iShares MSCI Emerging Markets Index (EEM)
  • iShares JPMorgan Emerging Markets Bond Fund (EMB)
  • iShares Latin America 40 (ILF)
  • iShares Barclays 20+ Year Treasury Bond (TLT)
  • Vanguard REIT ETF (VNQ)
  • SPDR Gold Shares (GLD)
  • PowerShares DB Commodity Index Tracking (DBC)
  • 3-month Treasury bills (Cash)

We compare original (SACEMS Base) and modified (SACEMS Granular), each month picking winners from their respective sets of ETFs based on total returns over a fixed lookback interval. We focus on gross compound annual growth rate (CAGR), gross maximum drawdown (MaxDD) and gross annual Sharpe ratio (average annual excess return divided by standard deviation of annual excess returns, using average monthly T-bill yield during a year to calculate excess returns) as key performance statistics for the Top 1, equally weighted (EW) Top 2 and EW Top 3 portfolios of monthly winners. Using daily and monthly total (dividend-adjusted) returns for the specified assets during February 2006 through October 2021, we find that: Keep Reading

Add Position Stop-gain to SACEMS?

Does adding a position take-profit (stop-gain) rule improve the performance of the “Simple Asset Class ETF Momentum Strategy” (SACEMS) by harvesting some upside volatility? SACEMS each months picks winners from among the a set of eight asset class exchange-traded fund (ETF) proxies plus cash based on past returns over a specified interval. To investigate the value of stop-gains, we augment SACEMS with a simple rule that: (1) exits to Cash from any current winner ETF when its intra-month return rises above a specified threshold; and, (2) re-sets positions per winners at the end of the month. We focus on gross compound annual growth rate (CAGR) and gross maximum drawdown (MaxDD) as key performance statistics for the Top 1, equally weighted (EW) Top 2 and EW Top 3 portfolios of monthly winners. Using monthly total (dividend-adjusted) returns and intra-month maximum returns for the specified assets during February 2006 through September 2021, we find that: Keep Reading

Add Position Stop-loss to SACEMS?

Does adding a position stop-loss rule improve the performance of the “Simple Asset Class ETF Momentum Strategy” (SACEMS) by avoiding some downside volatility? SACEMS each months picks winners from among the a set of eight asset class exchange-traded fund (ETF) proxies plus cash based on past returns over a specified interval. To investigate the value of stop-losses, we augment SACEMS with a simple rule that: (1) exits to Cash from any current winner ETF when its intra-month return falls below a specified threshold; and, (2) re-sets positions per winners at the end of the month. We focus on gross compound annual growth rate (CAGR) and gross maximum drawdown (MaxDD) as key performance statistics for the Top 1, equally weighted (EW) Top 2 and EW Top 3 portfolios of monthly winners. Using monthly total (dividend-adjusted) returns and intra-month drawdowns for the specified assets during February 2006 through September 2021, we find that: Keep Reading

Understanding the Variation in Equity Factor Returns

What is the best way to understand and anticipate variations in equity factor returns? Past research emphasizes factor return connections to business cycle variables or measures of investor sentiment (with little success). In his September 2021 paper entitled “The Quant Cycle”, David Blitz analyzes factor returns themselves to understand their variations, arguing that behavioral rather than economic forces drive them. He determines the quant cycle (bull and bear trends in factor returns) by qualitatively identifying peaks and troughs. He focuses on U.S. versions of four conventionally defined long-short factors frequently targeted by investors (value, quality, momentum and low-risk), emphasizing the most volatile (value and momentum). He also considers some alternative factors. Using monthly data for factors from the online data libraries of Kenneth French, Robeco and AQR spanning July 1963 through December 2020 (and for a reduced set of factors spanning January 1929 through June 1963), he finds that:

Keep Reading

Momentum and Reversal Drivers for Large U.S. Stocks

What drives 12-month (with skip-month) momentum and 1-month reversal effects among U.S. common stock returns?  In their July 2021 paper entitled “Mapping out Momentum”, Yimou Li and David Turkington decompose momentum and reversal effects into distinct industry/sector, factor (size, value, profitability, investment) and stock-specific contributions. In addition to full-sample results, they look at:

  • High and low volatility states, as defined by a threshold of 25 for average daily CBOE Volatility Index (VIX) during the month of stock return measurement.
  • Contributions of past winners versus past losers.
  • Two subsamples with breakpoint December 2009.

They focus on S&P 500 stocks to avoid concerns that any anomalies are due to market frictions or are not exploitable on a large scale. They assume a 3-day implementation lag in computing next-month returns. They examine statistical significance (t-statistic) rather than magnitude of anomaly returns. Using S&P 500 stock, sector/industry and factor data and daily VIX levels during January 1995 through December 2020, they find that:

Keep Reading

SACEMS Optimal Lookback Interval Stability

A subscriber asked about the stability of the momentum measurement (lookback) interval used for strategies like the Simple Asset Class ETF Momentum Strategy (SACEMS). To investigate, we run two tests on each of top one (Top 1),  equal-weighted top two (EW Top 2) and equal-weighted top three (EW Top 3) versions of SACEMS:

  1. Identify the SACEMS lookback interval with the highest gross compound annual growth rate (CAGR) for a sample starting February 2006 when Invesco DB Commodity Index Tracking Fund (DBC) becomes available and ending each of May 2012, 2013, 2014, 2015, 2016, 2017, 2018, 2019, 2020 and 2021. We consider lookback intervals of one to 12 months, meaning that earliest allocations are for February 2007 to accommodate the longest interval. The shortest sample period is therefore 5.3 years. This test takes the perspective of an investor who devises SACEMS in May 2012 and each year adds 12 months of data and checks whether the optimal lookback interval has changed.
  2. Identify the SACEMS lookback interval with the highest gross CAGR for a sample ending May 2021 and starting each of February 2006, 2007, 2008, 2009, 2010, 2011, 2012, 2013, 2014, 2015 and 2016. The shortest sample period is again 5.3 years. This test takes perspectives of different investors who devise SACEMS at the end of February in different years.

Using monthly SACEMS inputs and the SACEMS model as currently specified for February 2006 through May 2021, we find that: Keep Reading

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