Wednesday, February 26, 2014

Momentum As The Only Reliable Market Anomaly

Besides the temperature outside the NYMEX for natural gas.
From the Optimal Momentum blog (Oct. 2013):
Momentum...the Only Practical Anomaly
Interest in momentum is growing as it gains recognition as the premier market anomaly. Our purpose here is not to report on every item or research finding related to momentum. We prefer instead to point out those that are most important or interesting often because they seem exceptionally good, or, occasionally, because they seem exceptionally bad.

One exceptionally good piece of research is the working paper by Israel and Moskowitz (I&M) called "The Role of Shorting, Firm Size, and Time on Market Anomalies." This paper has important implications not only for momentum investors, but also for those who are interested in size and value  investment tilts. I&M look at all three with respect to firm size, long or short market exposure, and results stability over time.

Most research papers on relative strength momentum present it on a long/short basis where you buy  winning stocks and short losing ones. In some papers, you can find some long-only results buried in a table somewhere. Except in my papers, it can be challenging to find visual representations or detailed analyses of long-only momentum. However, I&M offer insightful analysis of long-only momentum. It is important to look at long-only results for two reasons. First, most investors are interested only in the long side of the market. Second, in the words of I&M:

Using data over the last 86 years in the U.S. stock market (from 1926 to 2011) and over the last four decades in international stock markets and other asset classes (from 1972 to 2011), we find that the importance of shorting is inconsequential for all strategies when looking at raw returns. For an investor who cares only about raw returns, the return premia to size, value, and momentum are dominated by the contribution from long positions.

Therefore, even if you are open to shorting, it does not make much sense from a return perspective. 

I&M charts and tables show the top 30% of long-only momentum US stocks from 1927 through 2011 based on the past 12-month return skipping the most recent month. They also show the top 30% of value stocks using the standard book-to-market equity ratio, BE/ME, and the smallest 30% of US stocks based on market capitalization. 
Long-only momentum produces an annual information ratio almost three times larger than value or size. Long-only versions of size, value, and momentum produce positive alphas, but those of size and value are statistically weak and only exist in the second half of the data. Momentum delivers significant abnormal performance relative to the market and does so consistently across all the data....MORE 

Unfortunately for all the Momo Mamas out there Optimal Momemtum posts very infrequently, most recently January 13, 2014.
Balancing the frequency there are some interesting tidbits for the hardcore among us e.g. from Sept 6, 2013:
Momentum Back Testing