Systematic Relative Strength

David Garff on momentum (The Journal of Investment Consulting, Volume 15, 2014):

Momentum is the “tendency of investmetns in every market and asset class, to exhibit persistence in their relative performance for some period of time” (Berger et al. 2009).

Since the first significant studies on momentum in the 1990s (Jegadeesh and Titman 1993; Asness 1994), this theory has been one of the most strongly tested in all of modern finance, with more than 300 academic and practical papers including 150 in the past five years. Asness et al. (1997), the first to evaluate momentum across countries, concluded that even accounting for currency effects, the momentum effect was consistent. In a subsequent study, Balvers and Wu (2004) revealed that a combination of short-term momentum and intermediate-term mean reversion provide strong risk-adjusted returns. Extending the work of Asness et al. (1997), Griffin et al. (2004) find that price and earnings momentum profits are significant globally.

Again, the theme that recent ouperformance tends to continue in the near term is consistent across geographies and asset classes.

John Lewis’ contributions to the body of knowledge of momentum investing can be found here, here, here, and here.

Past performance is not indicative of future results. Potential for profits is accompanied by possibility of loss. A momentum strategy is NOT a guarantee. There may be times where all investments and strategies are unfavorable and depreciate in value.

ETF Trends highlights the strong recovery of the PowerShares DWA Momentum ETF (PDP):

This year’s momentum sell-off is, mostly, in investors’ rearview mirrors. You know, the one caused by sharp retrenchments in biotechnology, Internet and social media stocks.

The one that sent beloved exchange traded funds such as the Global X Social Media Index ETF (NasdaqGM: SOCL) and theiShares Nasdaq Biotechnology ETF (NasdaqGM: IBB) to ominous flirtations with bear markets. [Momentum Lost in April]

Imagine how bad things were during the March/April momentum sell-off for ETFs that actually have the word “momentum” in their titles. The Powershares DWA Momentum Portfolio (NYSEArca: PDP) endured that nightmare, tumbling almost 8% from its March peak to its April trough. That decline was not bad compared to biotech, Internet and social media ETFs, but because PDP is framed as a momentum fund, it was cast in the same negative light even though the ETF holds no Internet or social media stocks and has only scant biotech exposure.

Too often those that are willing to highlight an ETF’s fall from grace are also reluctant to acknowledge that fund’s resurgence. Too bad because they are missing out on the fact that the $1.27 billion PDP is one of 30 ETFs (at this writing) to have touched a new all-time high Tuesday.

Some say the momentum factor as it pertains to ETFs is cooling.

PDP did not get the memo. With Tuesday’s modest gain, PDP is up 6.3% over the past 90 days while the S&P; 500 is higher by about 5% over the same period. [Overlooked Alternative Index ETFs]

As is the case with some other momentum ETFs, PDP reminds investors, and it is a critical reminder at that, that there is a big difference between dangerously inflated momentum as it pertains to high-flying stocks from the Internet and social media realms and steady, but still impressive price action. [Marrying Momentum With This ETF]

PDP tracks the Dorsey Wright Technical Leaders Index, “which takes into account, among other factors, the performance of each of the approximately 1,000 largest companies in the eligible universe as compared to a benchmark index, and the relative performance of industry sectors and sub-sectors,” according to PowerShares.

With the possible exception of Apple (NasdaqGS: AAPL), few if any of PDP’s top-10 holdings have the look of true momentum stocks. Again, the ETF holds no Internet and social media stocks. To be fair, PDP does hold some true momentum names, such as Netflix (NasdaqGS: NFLX) and Tesla (NasdaqGS: TSLA), but the ETF’s weights to those names are light.

What PDP does feature is a combined weight of nearly 48% to the consumer discretionary and industrial sectors, two laggard groups this year. Yet PDP is up almost 9% this year while cap-weighted discretionary ETFs are still trying to get to year-to-date gains of 3%. Traditional ETFs are clinging to gains in the 4% to 5% range.

PDP’s 15.7% allocation to the materials sector has been a boon for the ETF as five of the ETF’s six largest materials holdings have traded higher this year and four of those five names have posted gains north of 10%. [An ETF Trade for the Summer Blues]

Past performance is not indicative of future results. Potential for profits is accompanied by possibility of loss. A list of all holding for the trailing 12 months is available upon request. Dorsey Wright & Associates is the index provider for PDP. See www.powershares.com for more information.

The table below shows the performance of a universe of mid and large cap U.S. equities, broken down by relative strength decile and then compared to the universe return. Those at the top of the ranks are those stocks which have the best intermediate-term relative strength. Relative strength strategies buy securities that have strong intermediate-term relative strength and hold them as long as they remain strong.

Last week’s performance (8/18/14 – 8/22/14) is as follows:

This example is presented for illustrative purposes only and does not represent a past recommendation. The performance above is based on pure price returns, not inclusive of dividends or all transaction costs. Past performance is not indicative of future results. Potential for profits is accompanied by possibility of loss.