Another View of Industry Momentum

There have been a lot of posts on the power of the momentum anomaly lately. To mention two, there was my post, A Different Look at Industry Momentum, and a post by Mebane Faber at his excellent blog World Beta, Quantitative Strategies for Achieving Alpha. I know there have been more recently, but somehow I did not bookmark them.

This note considers whether the strength of the momentum effect might not be waning. Consider this:

This graph shows the excess returns of my industry momentum model over the past 12 years. Momentum has worked over that time period, but decreasingly so, with a few wipeouts along the way. Many will remember the worst of them in August 2007, when quantitative investing was decidedly crowded.

Remember, I view investment strategies using an ecological framework. There are many strategies that work on average, but often many of them are overpursued, and the excess returns have been competed away. Or, a strategy has been forgotten, relatively speaking, and now it might have some punch.

I am guessing that momentum as a factor is overplayed at present, and it might be wise to leave it to the side until the next wipeout. If that were to apply in the present market, it would mean the failure of the more stable parts of the market to retain value: consumer staples, utilities, health care, other cash flow spinning industries.

There are two ways that could happen: 1) a resurgence of the cyclicals, and 2) market collapse, where investors give up on all stocks, even stable ones. I’m not going to bet on either of those, but either is possible in this environment. If demand begins to rise in the world due to falling commodity prices, #1 is possible, and #2 would come from a continuing collapse in consumer demand.

Food for thought in this ugly environment. Invest carefully, the need for a margin of safety is more critical than ever.

Comments

[Moon Kil Woong:]

If the government's last ditch effort to save the economy is making a bad bank and taking assets from banks to it without penalty to existing banks, then it will be a cold day in hell before we see the end of such a monster. The Greenspan put will be fully proven and the taxpayer will get a fistful of losses. I assume such an agent will also have the delightful duty of sucking up the $40 or so trillion in bad derivatives that goes with them.

So in essence the budget deficit for 2009 if realized in the year the liabilities came onto the balance sheet would look something like $5-10 trillion. Why that would make even the federal government blanche. That's why I'm sure they will hide it under some sort of accounting fraud.

So yes, I see a resurgence of the zombies (banks) then look for a bad downside after it becomes clear what a big brown easter egg the government has laid. Mind you, no one even dares talk about when it will hatch and spawn a viable company.

You would think the government would have learned after their last two terrible monsters made a mess of the economy (Fannie Mae and Freddie Mac). I am curious to see how many monsters it can make before everyone runs from the stock market. Stability is the last thing that such entities herald.

Jan 28 02:32 PM

[Hefaistos:]

I disagree, the 'bad bank' is a reality tested and proven concept. It's exactly what's needed, to get away from the mark-to-market hysteria of assets, that is forced upon banks by auditors etc, but which is in reality irrelevant, since those assets were bought with the intention to keep until maturity.

To lift those ailing assets away and let them mature in peace will be good for banks and for the taxpayer as well, since the economy most likely will recover within the average maturity of those assets.

Jan 28 05:04 PM

[beegdawg007:]

Interesting observation. An observation....

Yesterday, I read the transcript of the US steel year-end announcement. One thing jumped out. For the past quarter US steel and all steel suppliers have been working down inventory. According to AISI US steel inventories are now at their lowest level in thirty years. That is what extreme fear does. My suspicion is that this is true for many industries throughout the world. Steel inventories are being worked off, auto inventories are being sold off, lumber inventories are being depleted, etc... So, what happens when some of this stimulus around the world finally kicks in. I think maybe... BAMM!!!! ... all at once, everywhere, production must be again cranked up because there is no inventory available. We certainly are not at the recovery stage yet, but we are near a bottom. The steel industry for example, actually saw some improvement in as new orders again started to book. Thermal coal prices have apparently bottomed throughout the world and steel prices are actually quite a bit off of the lows of Nov and Dec.

Across the world, over $2 trillion worth of development programs are now in the launch phase and interest rates are at 50 year lows. Combine that with ultra low inventories and... well.. we could really see a BAMM!!!

Jan 28 10:55 PM

[adAstra:]

We may be in the launch phase, but given the speed of bureaucracy, I wouldn't expect to see that BAMM for another year. Believe it or not, construction won't happen until after field data is collected, design concepts are proposed, refined and approved by the government (be it local, state, or federal). The design process is going to take several months. Only once that ends will actual construction begin.

Jan 29 04:00 PM

[Old Trader:]

I dunno...I heard, on the news, some civil engineer type talking about 2-3 billion $ of "shovel ready" projects in the water supply/sewage treatment area. Granted, stuff like new rail (either light or heavy), airport expansions, etc., are "long lead time" items...several years, at the least, before the first spade of dirt gets turned, but I think it wouldn't be too hard to get off to a reasonable "flying start".


On Jan 29 04:00 PM adAstra wrote:

> We may be in the launch phase, but given the speed of bureaucracy,
> I wouldn't expect to see that BAMM for another year. Believe it or
> not, construction won't happen until after field data is collected,
> design concepts are proposed, refined and approved by the government
> (be it local, state, or federal). The design process is going to
> take several months. Only once that ends will actual construction
> begin.

Jan 29 09:40 PM