Momentum isn’t everything, but it’s hardly chopped liver. You could spend the next several months reviewing the literature published over the past two decades that make a case for showing a little respect for price momentum, or the tendency of prices to continue moving in the same direction relative to recent history. Should you focus exclusively on momentum for managing portfolios? No, of course not. But neither should you ignore it.
Skeptical? Take a look at a newly published summary of the momentum factor by Professor Tobias Moskowitz. a finance professor at the University of Chicago. And here’s a recent article on momentum I wrote for Financial Advisor magazine.
Momentum as a risk factor is old news, but it isn’t easily explained. Yet it’s hard to dismiss it as irrelevant. Yes, there are hazards to consider, including the inevitably for a given direction in momentum to eventually run up against mean reversion—i.e., momentum reverses at some point. Positive momentum always and everywhere gives way to negative momentum, and vice versa. The question is always: When? A very rough rule of thumb is using 12 to 24 months as a benchmark for deciding if momentum is long in the tooth. Some momentum strategies define momentum over the past 12 months as robust. But by 24 months, if not earlier, the strategies jump ship. Much depends on the asset class, of course, along with the economic context and other factors. But this is probably a good place to start a momentum analysis.
The various caveats aside, how do the major asset classes stack up on momentum these days? For some insight, I reviewed ETF/ETN proxies for the major asset classes using data from StockCharts.com. Specifically, I looked at closing prices for 11 ETFs/ETNs as of Friday, August 27 relative to the 200-day moving averages, based on data from StockCharts.com. Some strategists argue that price below the 200-day moving average is a near-term bearish signal; price above this average is bullish.
There are no guarantees, but as Mark Hulbert wrote earlier this year: the 200-day moving average trend strategy is tough to beat when it comes to market timing. Mebane Faber in The Ivy Portfolio comes to a similar conclusion in a detailed study of using momentum signals to manage a multi-asset class portfolio.
As for the latest 200-day moving average profiles, here’s what I found:
Funds trading below their 200-day moving average:
U.S. Stocks (VTI)
Foreign Developed Mkt Stocks (VEA)
Funds trading above their 200-day moving average:
Emerging Market Stocks (VWO)
Emerging Market Bonds (PCY)
U.S. Bonds (BND)
Foreign Gov’t Inflation-Linked Bonds (WIP)
Foreign Dev Mkt Bonds (BWX)
High Yield Bonds (JNK)
This isn’t terribly surprising. Bonds generally have been rising in price, thanks to deflation/double-dip recession fears. For the same reason, stocks have been trading below this average. Risk aversion is alive and kicking.
But there are some quirks. REITs are well above their 200-day moving average while commodities are below.
Given the higher-than-usual uncertainty surrounding the macroeconomic outlook, interpreting this information carries more than the usual risk. Momentum is about trend, but all trends eventually reverse. Momentum can be a powerful short/medium-term signal for tactical asset allocation, but it’s far from flawless.
Nonetheless, there’s no question about where market sentiment lies. The crowd generally favors bonds and is cautious on stocks (particularly in developed markets), REITs and commodities. The trend may roll on for a time until the economic news inspires thinking differently. Meantime, momentum is king.