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Brett Arends’s ROI: Momentum stocks can give you an edge, researchers say

Anyone saving for their retirement would like an edge. Earn better returns than the stock market, and you could quit the rat race sooner, retire richer and ideally have more fun.

But is it possible without taking crazy risks, or betting on one of those dubious “systems” for beating the house at roulette?

It could be.

Researchers say investing in so-called “momentum” stocks — which means buying the stocks that have already risen in the expectation that they will keep doing so — is the best documented and most durable “edge” in the market.

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Its success “is a well-established empirical fact,” and can be demonstrated across multiple assets and over 212 years of stock market data argues money manager Cliff Asness and his colleagues. It is “the premier market anomaly,” writes analyst Gary Antonacci. It trounces a simple “buy and hold” stock market strategy going back almost 100 hundreds, estimates money manager Meb Faber.

And, crucially, it is the only one of the so-called factors that seems to be getting stronger, not weaker. So, at least, argue Simon Smith of the Federal Reserve and Allan Timmermann, a finance chair at UC San Diego. While investing in cheap “value” stocks and in small-company stocks has failed to produce the promised superior returns in recent years or decades, momentum has been getting better.

Over the past five years, for example, the iShares MSCI USA Momentum Factor ETF

has outperformed the SPDR S&P 500 ETF Trust

by a clear 30 percentage points, and the iShares International Momentum Factor ETF

the Vanguard FTSE Developed Markets ETF

by 12 points. During the turmoil of the Covid crisis since March 2020, you’ve made way more money just riding hot “momentum” stocks like Tesla

and Apple

than you did just sticking with the S&P 500.

So is that it? Just buy a “momentum” fund and forget about it?

Not so fast. Never mind that momentum investing has actually trailed the market so far this year. Or that momentum stocks were badly whipsawed in market turmoil a year ago.

Most important: You may be able to do better.

So estimates Joachim Klement, a trustee of the CFA Institute Research Foundation and chief strategist at Liberum in London. Since early in the crisis last year he has been running a more sophisticated momentum stock portfolio. It has managed to beat straight momentum, with less risk.

Klement’s so-called “Invincibles” portfolio consists of stocks that simultaneously show positive momentum over multiple periods, not just one or two. These are stocks that have risen over the past month, and over the previous two, five and 11 months. Academic research has strong outperformance for stocks showing “overlapping” momentum over multiple periods. Klement updates the portfolio for clients monthly.

So this portfolio has, for example, produced almost twice the returns of MSCI USA Momentum so far this year, rising 33% against 17% for USA Momentum (and 25% for the S&P 500). And that’s even after allowing for huge theoretical trading costs — 1% every time you buy a stock and 1% every time you sell it. In the U.K. the outperformance has been even bigger — because, Klement argues, there he has included small and medium sized stocks and not just big companies. The momentum effect seems stronger among smaller and midsize stocks.

Astonishingly, since May of last year the Invincibles portfolio has had just one negative month.

And there is an inbuilt cautious bias to this portfolio as well, because it only holds stocks that have positive trailing returns. In a bear market you may be invested in nothing whatsoever. As Meb Faber and others have pointed out, momentum strategies can help you avoid the worst market turmoil.

Klement’s latest Invincibles list for the U.S. includes about 100 of the S&P 500 stocks, from Ford
General Motors

and Tesla

to Chevron
Boston Properties
Home Depot
Amazon, timber company Weyerhauser

and restaurant chain Darden

One of the most interesting aspects of this portfolio though is not only that it has a lot of hard numbers backing it up, but that it is in theory accessible to any ordinary investor who can screen stocks by monthly performance.

My biggest problem with “momentum” as an investment strategy is that you are basically abandoning any attempt to do your own fundamental analysis whatsoever. It feels to me like the stock market equivalent of “social” media, jumping on the latest crowd mania regardless of any merits. 

But maybe that’s why I should do it. If Rome is falling, and the Dark Ages are coming, shouldn’t I just give up and bet on the Vandals?

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