The Aleph Blog » Blog Archive » A Different Look at Industry Momentum

A Different Look at Industry Momentum

Since 1996, I’ve been aware of research that indicates that momentum works in the stock market.  My quandry as a value investor has been to figure out how to incorporate it, if at all.  My approach was to play for the weaker mean-reversion effect, and have a lower turnover rate than would be needed in a value plus momentum strategy.  I am now questioning that decision, even though I have done well in the past. I just finished the initial stages of an analysis that will be available to my clients highlighting the value of momentum strategies.  Using the industries in the S&P 1500 Supercomposite, from October 1995 to December 2008, investing in the Supercomposite yielded an annualized price return of 4.0% (with dividends 5.5%).  The annualized price return for each momentum quintile, where momentum was defined as return over the previous 200 business days, was as follows:

  • Top — 11.3%
  • Second — 4.4%
  • Middle — 6.5%
  • Fourth — 1.7%
  • Bottom — 0.2%

Now, there are several weaknesses with this analysis:

  • No trading costs.  (I think those could be minimized.)
  • Some industry groups are small, and could not accommodate a lot of money.  (Probably a large problem)

That said, even with those difficulties, there should still be some excess return from following a momentum strategy.  What industries would that imply at present?

  • Education Services
  • Brewers
  • Biotechnology
  • Water Utilities
  • Insurance Brokers
  • Environmental and Facilities Services
  • Hypermarkets & Supercenters
  • Health Care Services
  • Packaged Foods
  • Pharmaceuticals
  • Gold
  • Multi-Utilities
  • Restaurants
  • Tobacco
  • Household Products
  • Home Improvement Retail
  • Food Distributors
  • Distillers & Vintners
  • Reinsurance
  • Food Retail
  • Integrated Oil & Gas
  • Health Care Technology
  • Airlines
  • Health Care Supplies
  • Electric Utilities
  • Distributors

For a quick summary, think staples, utilities, health care (excluding insurance), and other industries with stable cash flow.  This is about as bearish as it gets, so be careful for now, and don’t speculate on when the turn in the economy will come.  Focus on what consumers always need. Or, as James Grant once said (something like), “Could this be a bull market in cash?” ;)

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2 Responses to A Different Look at Industry Momentum

  1. matt says:

    Mr. Merkel:

    There is a book by O’Shaughnessy (or something like that) called “What works on Wall Street.” In it, he creates a hybrid strategy based on several value ratios and relative strength over differ lengths of time. It had fantastic risk adjusted returns (and overall returns).

  2. Hi David, I have enjoyed the benefit of your writing and analysis for many years. Our fund is based upon Soros’ theory of reflexivity, which I believe is the main cause (along with some behavioral inefficiencies) of the persistency of the momentum effect.

    A change (could be macro, sector, or company-specific) occurs at a company that triggers a feed-back loop between the stock price and the company fundamentals. Another way of looking at it is through the idea of “real options”. Certainly a company whose stock has gone up has a lot more “real options” than one that has declined. Now the management may ultimately use those options to destroy value, thus triggering a negative reflexivity cycle but in the interim, the equity value of a company with more “real options” should be worth more than a company with less.




David Merkel is an investment professional, and like every investment professional, he makes mistakes. David encourages you to do your own independent "due diligence" on any idea that he talks about, because he could be wrong. Nothing written here, at RealMoney, Wall Street All-Stars, or anywhere else David may write is an invitation to buy or sell any particular security; at most, David is handing out educated guesses as to what the markets may do. David is fond of saying, "The markets always find a new way to make a fool out of you," and so he encourages caution in investing. Risk control wins the game in the long run, not bold moves. Even the best strategies of the past fail, sometimes spectacularly, when you least expect it. David is not immune to that, so please understand that any past success of his will be probably be followed by failures.

Also, though David runs Aleph Investments, LLC, this blog is not a part of that business. This blog exists to educate investors, and give something back. It is not intended as advertisement for Aleph Investments; David is not soliciting business through it. When David, or a client of David's has an interest in a security mentioned, full disclosure will be given, as has been past practice for all that David does on the web. Disclosure is the breakfast of champions.

Additionally, David may occasionally write about accounting, actuarial, insurance, and tax topics, but nothing written here, at RealMoney, or anywhere else is meant to be formal "advice" in those areas. Consult a reputable professional in those areas to get personal, tailored advice that meets the specialized needs that David can have no knowledge of.

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