momentum in stock returns

wrote

I think what's most talked about is diversifying. That is, holding value and growth; small and large and in-between; international and domestic; etc.

The three major U.S. stock exchanges trade some 9000 stocks. Using the "momentum strategy" of these articles, one is supposed to hold the top 10% each month (based on the last

11 months of performance). This would be some 900 stocks. Turnover is remarked to be some 91%. Problems that would have to be solved before giving this "momentum strategy" any credence:

-- Effects of transaction costs (stock commissions). Ballpark, each month we're looking at $5 per trade (through a discount broker) with around 800 buy orders and 800 sell orders. Hence $96,000(!) a year. Can this strategy be modified so the transaction costs would not kill the ordinary investor? I mean, apart from the obvious modification of buying a mutual fund with this strategy. Are there mutual funds with this strategy? If not, Eddy Elfenbein has discovered a gold mine, hasn't he? Lemme know. :-)

-- Effects of Short Term Capital Gain taxes

I think the 91% turnover was an annual figure reducing tranaction costs by an order of magnitude. But, you're right, that's still a pretty hefty amount just for transaction costs. You'd need to put at least $100k or so against this strategy to keep the transaction costs from eating up the historical premium (with $5 trades).

Don't momentum mutual funds exist? How do they perform?

-Will

william dot trice at ngc dot com

"Will Trice" wrote

I think you're right. That is, re-reading the context carefully, it has to be an annual figure. (Eddy, the author of the original article, confirmed this earlier today at one of his sites.)

So we're down to about $8000 in transaction costs, using a discount broker and at about $5 a trade.

I agree. Just to break even relative to the long term buy and hold value yada approach, my rough calculations put the number between about $120k and $160k, with the aforementioned assumptions, plus assume the effective short term capital gain tax bite is somewhere between about 10% and 20%. Knock on wood, since I believe short term capital gain tax rates have varied quite a lot over the years.

So say one has $200k to boost one's income. Should one use this momentum "strategy" so one might do a little better than a conventional, buy and hold value yada method? Theoretically and according to this article and its citations, history says one would make about 2 points more (12.2% effective return after transaction costs and taxes) than using the conventional approach. I know that compounds to a lot more over time. Still, I think I'd want to consider how a five-year bear market might ravage such a portfolio early on first. A Monte Carlo simulation might yield more meaningful results.

Plus I do not like banking on short term capital gain tax rates not fluctuating much, especially as my income would rise.

Lastly, the underlying "theory" of this approach is something for which I cannot argue using sound economic principles. Banking on a "rational" exploitation of the "mass hysteria" that often drives short term stock price increases and declines ultimately just stinks of gambling to me.

If they stood out, then as I think you know, I think we'd know about them.

I don't necessarily disagree with this, but maybe one could consider trying to capitalize on short term movements just a logical (and extreme) extension to value investing? Many value strategies suggest taking advantage of price declines (though obviously this isn't really momentum investing).

-Will

william dot trice at ngc dot com

"Will Trice" wrote

Two cents: I think I'd call this (1) a rationalization of succumbing to the temptation to try to make money quicker, and (2) a bastardization of value investing. ;-)

I think real value investors (Graham purists and not-so-pure types) tend to overwhelmingly agree when a stock is a "growth" stock buy vs. a "value" stock buy. E.g. if company fundamentals show the stock to be way overvalued, value investors won't touch it. IOW I don't think this extension is "logical," since it rejects fundamental tenets of what is a "value" stock.

I would not, because value investors are more often buyers (sellers) of stocks that have fallen (risen) in price, the opposite of what a momentum investor would do.

An old Wall Street saying, worth what any Wall Street saying is worth, is "Value investors sell to growth investors. Growth investors sell to momentum investors. Momentum investors sell to value investors."

-- Doug

I didn't mean to imply that momentum investing is a form of value investing (you snipped this part of my post out of your quote). I was addressing Elle's point about exploiting short term price movements. Value investing often capitalizes on downward movements in stock prices when those prices are deemed irrational by a value investor, yet value investors are not generally considered gamblers.

-Will

william dot trice at ngc dot com

I really like things like this - humorous sayings that convey a message.

-HW "Skip" Weldon Columbia, SC