Momentum investing has long been a popular strategy among investors, but not all momentum approaches are created equal. Validea’s Quantitative Momentum strategy, based on the research of Wes Gray and Jack Vogel as outlined in their book “Quantitative Momentum,” offers a sophisticated, evidence-based approach to capturing momentum in the stock market.
Understanding Momentum Investing
Before diving into the specifics of the Quantitative Momentum strategy, it’s important to understand the basic concept of momentum investing. This approach is rooted in the observation that stocks that have performed well in the recent past tend to continue performing well in the near future. Conversely, stocks that have underperformed tend to continue lagging.
Momentum investing goes against the grain of traditional value investing, which seeks to buy low and sell high. Instead, momentum investors aim to buy high and sell even higher, capitalizing on the continuation of existing trends in the market.
The Quantitative Momentum Approach
What sets the Quantitative Momentum strategy apart is its rigorous, data-driven methodology. Rather than relying on subjective assessments or simple price momentum, this approach uses multiple factors to identify stocks with the strongest momentum characteristics.
Here are the key criteria used in Validea’s interpretation of the Quantitative Momentum strategy:
- Define the Universe: The strategy starts by considering stocks with market capitalizations above $150 million and daily dollar volume above $2 million. This ensures sufficient liquidity and tradability.
- Twelve Minus One Momentum: This criterion looks at a stock’s performance over the past year, excluding the most recent month. The strategy selects stocks in the top 10% of the universe based on this metric. Excluding the most recent month helps avoid short-term reversals that can occur due to investor overreaction.
- Return Consistency: Gray and Vogel’s research showed that momentum is most likely to persist when it’s consistent. The strategy measures this by calculating the percentage of days with positive returns minus the percentage of days with negative returns over the past year, multiplied by the sign of the twelve minus one momentum.
- Seasonality: While not always included in the scoring, the strategy considers potential enhancements from rebalancing in the month before quarter-end to take advantage of window dressing and tax-related effects.
Why This Strategy Works
The Quantitative Momentum strategy’s effectiveness stems from its ability to identify stocks with strong, consistent momentum while filtering out those with more volatile or erratic price movements. By focusing on intermediate-term momentum and return consistency, the strategy aims to capture the momentum effect while minimizing exposure to short-term reversals or noisy price data.
Moreover, the strategy’s quantitative nature removes emotional biases that can often plague momentum investors. It provides a systematic approach to identifying momentum stocks, which can be particularly valuable in turbulent market conditions.
Current Strategy Picks
Let’s look at five stocks that currently pass Validea’s Quantitative Momentum strategy:
- COST (Costco Wholesale Corporation) Costco, the membership warehouse giant, scores a perfect 100% on the Quantitative Momentum strategy. The stock has shown strong and consistent momentum, with a twelve minus one month return of 56.34%, ranking it in the top 10% of stocks. Its return consistency is also impressive, placing it in the 1st percentile of the database.
- EME (EMCOR Group Inc) EMCOR Group, a specialty contractor and provider of electrical and mechanical construction services, also receives a 100% score. The company’s twelve minus one month return of 102.27% and its return consistency ranking in the 1st percentile demonstrate exceptional momentum characteristics.
- KNF (Knife River Corp) Knife River, an aggregates-based construction materials provider, scores 100% on the strategy. With a twelve minus one month return of 66.67% and a return consistency ranking in the 1st percentile, it shows strong and steady momentum.
- QCOM (Qualcomm Inc) Qualcomm, a leader in wireless technology, also achieves a perfect 100% score. Its twelve minus one month return of 88.11% and return consistency ranking in the 1st percentile indicate robust momentum.
- VIRC (Virco Mfg Corp) Virco, a manufacturer and supplier of furniture for educational markets, rounds out the list with another 100% score. The company’s impressive twelve minus one month return of 262.70% and return consistency ranking in the 1st percentile showcase exceptional momentum.
Implementing the Strategy
While the Quantitative Momentum strategy offers a powerful framework for identifying momentum stocks, investors should keep a few considerations in mind:
- Regular Rebalancing: Momentum strategies typically require more frequent rebalancing than value-oriented approaches. The optimal frequency can vary, but monthly or quarterly rebalancing is common.
- Transaction Costs: Higher turnover can lead to increased transaction costs. These should be factored into any implementation of the strategy.
- Tax Implications: More frequent trading can have tax consequences in taxable accounts.
- Risk Management: While momentum strategies can deliver strong returns, they can also experience significant drawdowns during momentum crashes. Proper diversification and risk management are crucial.
- Combining with Other Factors: Some investors may choose to combine momentum with other factors like value or quality for a more balanced approach.
Further Research
