Are momentum-focused investment strategies dead? MarketWatch’s Mark Hulbert recently highlighted some new data that indicates they are not.
Hulbert says that after “spectacular losses” in parts of 2008 and 2009 — many began to believe that a momentum-focused stock-picking approach — which keys on stocks with the best recent performance — was no longer effective. But, Hulbert says, “New research … has found that, by following a simple rule of thumb, you can markedly increase your odds of sidestepping so-called momentum crashes — periods in which momentum produces losses so disastrous as to dramatically reduce the long-term attraction of the approach. Since momentum strategies in all other months continue on balance to be quite profitable, the approach may therefore have merit after all.”
The research comes from Professors Kent Daniel and Toby Moskowitz, who found “that what led to the last decade’s momentum crashes is not new — huge levels of volatility during times in which the market is markedly off its recent high,” Hulbert says. “It’s just been so long since there was another decade that saw anything as lethal to momentum as what we’ve experienced recently — the 1930s, in fact — that most investors mistakenly concluded that the character of the markets had permanently changed and momentum was dead.”
Switching to cash when volatility spikes and the market is well off its high could thus be a way to sidestep momentum crashes, Hulbert says, though Daniel stressed that the method is not foolproof. As for what this means for the current environment, “The implication of the new research is that the current environment is a relatively safe one in which to pursue momentum strategies,” Hulbert writes. “That’s because the stock market is only modestly off its recent high and, in addition, the CBOE’s Volatility Index currently is relatively low — below 17, in fact, versus a long-term average around 20.”