Price momentum factor is not dead
There has been much talk in the past few years among quantitative investors that momentum as a stock selection factor is dead. However, the StarMine quant research team at Thomson Reuters has found that over time, factors fluctuate between periods of over and under performance. In fact, quant factors often begin performing well soon after many investors abandon them. Although price momentum signals have performed poorly in recent years, we noticed that momentum was turning around in 2011.
The accompanying chart plots the decile spread of the StarMine Price Momentum (Price Mo) model, a signal that combines information from multiple dimensions of price momentum – from the positive autocorrelation in returns at the 3-12 month time horizon to the negative autocorrelation in returns at short time horizons. The universe for this analysis was the Russell 3000 and the portfolios were rebalanced monthly.
StarMine Price Mo has seen strong performance year-to-date, with particular strength observed in the past few months. This has been a bit surprising as momentum signals generally struggle during periods of market volatility and sharp changes in market direction as we have seen since July.
During periods of high volatility, investors demonstrate signs of risk aversion and flock towards the relative safety of stocks with good earnings quality. Indeed StarMine EQ, an earnings quality signal based on accruals, cash flow, and operating efficiency, has performed strongly in 2011. The figure plots the cumulative decile spread for portfolios formed from StarMine EQ, with monthly rebalancing.
Although StarMine EQ has seen smooth and positive performance in 2011, the factor performed particularly strongly during the highly volatile months of July – September. Although a decile spread is compared to a baseline of zero, the figure below includes the performance of the Russell 3000 index, with monthly rebalancing, for reference.
As can be seen in this chart, it’s a good time to reconsider momentum as an important factor in your multi-factor model.
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