Swedroe: Momentum Across Time & Asset Classes

215-year lookback of results provides plenty of empirical insight.

The academic study of price momentum has intensified considerably since 1993, the year Narasimhan Jegadeesh and Sheridan Titman’s paper, “Returns to Buying Winners and Selling Losers: Implications for Stock Market Efficiency,” appeared in The Journal of Finance. The authors found that buying winning stocks and selling losers generated significant positive returns over three- to 12-month ownership.

A recent contribution to the body of literature exploring various aspects of price momentum is a May 2015 study from Christopher Geczy and Mikhail Samonov, “215 Years of Global Multi-Asset Momentum: 1800-2014 (Equities, Sectors, Currencies, Bonds, Commodities and Stocks).”

Looking At A Long Timeline

The authors set out to create and examine the longest possible history of the global asset momentum effect to more thoroughly understand its time-series properties and to better explain general characteristics of the phenomenon already discovered in more recent history.

Using databases from Global Financial Data and additional information available through Bloomberg, the authors created an expanded data set that goes back to 1800 and includes 47 country equity indexes, 48 currencies (including the euro), 43 government bond indexes, 76 commodities, 301 global sectors and 34,795 U.S. stocks.

Following is a summary of Geczy and Samonov’s findings:

• The 215-year history of global multi-asset class price momentum generated for the study showed that returns to momentum were consistently significant for each of the six asset classes examined (country equities, currencies, country government bonds, commodities, global sectors and U.S. stocks).
• Between 1800 and 2014, country equity momentum (price-only) had the largest long/short spread of the six asset classes. The premium was 0.88 percent per month (t-stat 10.6). Using total returns, the premium was smaller, but still clocks in at 0.57 percent per month (t-stat 6.8). The second-largest momentum premium appeared in currencies, with a spread of 0.51 percent per month (t-stat 9.6). U.S. stock momentum generated a premium of 0.51 percent per month (t-stat 6.0), global sector momentum generated a premium of 0.36 percent per month (t-stat 6.6) and global country bond momentum generated a premium that averaged 0.13 percent per month (t-stat 2.3). A cross-asset class momentum strategy, consisting of four asset classes, generated a premium of 0.45 percent per month (t-stat 10.2).
• Inverse commodity momentum generated a premium of 0.45 percent per month (t-stat 5.5). This finding on inverse momentum is interesting and it contradicts other studies. However, Geczy and Samonov used spot prices where other researchers used futures prices. They employed spot prices because futures prices have only become available in recent decades. However, spot prices, unlike futures prices, are not investable.
• The long/short momentum portfolios exhibited significant variation of beta compared with the average return of the corresponding asset class from which the portfolios were formed. In other words, the longer an up- or downmarket state persists, the larger the absolute value of the momentum portfolio’s beta, creating a dynamic risk profile for momentum over a given market cycle. Overall, for every additional month a given market state continued, the combined momentum long/short portfolio beta increased by 0.01 percent (t-stat 19.0) in the direction of the market return.
• There is consistent evidence of long-run reversion and short-run continuation, with the exception of U.S. stocks. U.S. stocks experience a short-run reversal, which is why the most recent month is excluded by most practitioners.
• Over the long run, bond momentum leads country equity returns.
• Momentum outperforms its “cousin” effect—trend—although both remain highly significant.
• About 60 percent of the premium in equity momentum comes from the long side. For currency momentum, the figure is 35 percent. For global sector momentum, the figure is 44 percent. For cross-asset-class momentum, half the premium comes from the long side. These are important figures, because long-only momentum avoids the crash risk of long/short momentum strategies.
• Momentum profits are much higher following upmarkets than following downmarkets.
• While the average five-year rolling correlation among the seven long/short momentum portfolios over the full period was quite low—9 percent—with long cycles of variability, correlations have been trending upward since reaching a low point in the 1950s. As of May 2014, the five-year cross-momentum correlation reached an all-time high of 41 percent. The upward trend in correlations strongly indicates that the diversification benefit of momentum investing across global asset classes has been significantly diminished. It seems likely the increase is due to continued global market integration as well as increased allocation of investment capital to momentum strategies. This has risk management implications for momentum-tilted strategies.

Periods Of Inconsistency

While the evidence demonstrates a robust momentum premium across asset classes over the long term, the authors emphasize: “There are many decade-long periods when the long-short returns to momentum are negative, highlighting the inherent risk in this strategy.”

Using the Fama-French momentum factor and Center for Research in Security Prices data, we can look at the cumulative returns to momentum over 10-year periods.

Examining only calendar years for the period 1927 through 2014, there are 14 different 10-year periods when momentum produced negative total returns. Even in considering nonoverlapping periods, five such periods exist. Yet over the full period, the momentum premium reached an annual average of 8.4 percent a year (producing compound return of 6.9 percent).

Patience, Discipline & Strong Belief

One conclusion we can draw from these results is that whether we are talking about the equity premium, the value premium or the momentum premium, investors require patience and discipline—aided by strong belief—to benefit from most strategies.

Geczy and Samonov’s study adds to the evidence that the momentum effect isn’t a just product of data mining, but is highly variable over time. The positive premium has continued after its published discovery in both the U.S. market and international markets as well as across asset classes. Results from this study are supported by the results from the 2012 study “Value and Momentum Everywhere,” which traces the power of the momentum anomaly across the globe.

One of the more common mistakes investors make is to view the risk and return of assets in isolation. The right way to view assets is to determine how their addition impacts the risk and return of the entire portfolio.

Diversification Benefit

For investors who tilt their portfolios toward value strategies (meaning they have a larger than market exposure to the value factor) even if the momentum premium is low or negative, the research demonstrates exposure to the momentum factor is still important for diversification purposes.

The reason for this is because the value and momentum factors exhibit a strong negative correlation. From 1927 through 2014, the monthly and quarterly correlations of the U.S. value and momentum factors were about -0.4, and the semiannual and annual correlations were about -0.26.

Perhaps the best illustration of the diversification benefit provided by momentum is from the paper “Momentum in Japan: The Exception that Proves the Rule.”

Stand-alone Vs. Portfolio Results

The authors showed that while the momentum strategy, on a stand-alone basis, has not “worked” in Japan, a portfolio with weightings of about 30 percent momentum and 70 percent value would have produced a higher Sharpe ratio than a 100 percent value portfolio.

Finally, the 2014 study “Fact, Fiction and Momentum Investing” provides further support.

In their Myth #7, the authors asked the question: “If the momentum factor went to zero would you still want to have exposure to momentum in your portfolio?” They showed that because of its diversification benefits, even if the premium went to zero, investors would still benefit from some exposure to momentum.

Larry Swedroe is the director of research for The BAM Alliance, a community of more than 140 independent registered investment advisors throughout the country.