Important insight from Mark Hulbert at MarketWatch:
Don’t give up on momentum stocks just because you worry the bull market may be nearing its end.
That’s because, contrary to popular belief, such stocks do not tend to be among the biggest losers when the market heads south. In fact, during bear markets, high-momentum stocks tend to do markedly better than those at the opposite end of the spectrum.
Momentum is typically measured over the trailing 12 months. So the stocks with the highest momentum are those with the best returns over the previous year, while those with the worst returns have the lowest momentum. A substantial body of academic research has documented that high-momentum stocks, on average, have significantly outperformed the market over the past century, while stocks with the least favorable momentum have markedly lagged.
Despite that strong academic support, however, many erstwhile followers of momentum strategies get particularly nervous when bear-market anxiety heats up. They worry that stocks with the highest momentum when the market is rising will be among the biggest losers when the market falls.
Some resort to a surfing analogy to express their concern: While a surfer rides high so long as his wave continues, he crashes when that wave comes to an end.
Compelling as this surfing analogy may be, however, it is misleading, according to Tobias Moskowitz, a principal at hedge fund firm AQR and a finance professor at the University of Chicago.
He told me that “while high-momentum stocks can be expected to lose during a bear market, historically, at least, they have not suffered significantly more than the overall market, and often fare better. Regardless, such stocks on average have fared better during bear markets than stocks with the worst trailing 12-month returns — those with the lowest momentum.”
“In fact,” he continued, “the times when high-momentum stocks fare worse than low-momentum stocks have come at the beginning of a new bull market — not at a bull market’s end or the beginning of a new bear market. Furthermore, it’s not that high-momentum stocks suffer at such times; their poor relative performance is caused by the sometimes exceptional gains of low-momentum stocks.”
Outstanding writing on risk to high momentum stocks.
It would be interesting to hear his take on mid level stocks. Comparing High to Low is always going to be subjective, particularly with DWA rules based decisions because, once it is no longer a high-momentum stock it is removed and replaced with a new high-momentum security….presumably, and assumptively, one that has risen from the mid-momentum ranks.
Excellent posting Andy.
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