My classic momentum screen, which focuses on going long on the 10 best blue-chip performers of the preceding three months and short on the 10 worst performers, offers both the most potential and the most risk when a single, strong trend emerges in the market. Often the screen struggles for clear direction, but there's no lack of a thematic impetus this quarter. The theme in question is the recent fall in the oil price and the big winners and losers from that decline. If the theme endures for another three months, the screen should perform extremely well. However, if the trend is flipped on its head, things are going to get ugly.
Many academic studies suggest simple momentum investing works well over time, which implies that most investment themes have a tendency to persist and develop over time before petering out rather than going quickly into sharp reverse. Arguably that suggests the risk is skewed slightly to the upside for this quarter's very focused Long and Short portfolios. The Long and Short portfolios are not totally binary bets on the oil price, though. Six of the 10 longs do fall outside the oil-price theme and the same is true for three of the shorts. That said, concerns are developing that some beneficiaries of low oil prices, such as airlines, could ultimately become victims as favourable conditions encourage fiercer competition.
It's not only academic studies that suggest momentum works. My own attempt at tracking the performance of a blue-chip momentum portfolio boasts impressive returns and the performance of last quarter's Long and Short portfolios have added to the impressive track record (see table). Indeed, with hindsight, oil-related themes were already at play when the previous portfolios were selected on 15 September. That meant a number of oil-related 'shorts' put in an extremely strong performance (a strong performance for shorts meaning big share-price falls).
| 15 Sep Longs | 15 Sep Shorts | ||
|---|---|---|---|
| Name | Performance | Name | Performance |
| Dixons Carphone | 14.4% | Tullow Oil | -40.1% |
| Persimmon | 13.3% | Petrofac Limited | -23.3% |
| intu properties | 4.6% | Tesco | -18.3% |
| Ashtead Group | 2.3% | IMI | -10.7% |
| Pearson | 1.7% | Royal Mail | -4.2% |
| ITV | -0.1% | Hargreaves Lansdown . | -0.1% |
| Direct Line | -0.5% | Kingfisher | 0.2% |
| Next | -1.9% | Admiral Group | 1.1% |
| SABMiller | -8.2% | Babcock International | 8.7% |
| Glencore | -10.5% | Associated British Foods | 21.4% |
| Average | 1.5% | Average | -6.5% |
| FTSE 100 | -1.2% | FTSE 100 | -1.2% |
Source: S&P CapitalIQ
Since I began monitoring this classic momentum strategy at the height of the pre-credit-crunch market in 2007, the Longs have produced a cumulative capital return - which excludes dividends, dealing costs and spreads - of 98.4 per cent compared with a 1.8 per cent decline by the FTSE 100 and a 20.7 per cent drop in the value of the shorts.
Over the past year from 15 December 2013 the screen has put in a strong performance, too. The impressive full-year numbers for the Longs were substantially boosted by an extremely strong first quarter (see bar chart below). For the year as a whole the Longs are up 10.6 per cent compared with 4.4 per cent from the FTSE 100. And, thanks largely to the big fall in the most recent quarter, the shorts have underperformed the market with a rise of just 3.4 per cent over the year.
The production cycle of the Investors Chronicle magazine means the Long and Short portfolios listed in this article do not quite represent a full three-month performance period and instead reflect a period from 15 September to 4 December - as opposed to the official quarterly end date of 15 December. Future performance calculations will be based on portfolio constituents determined by the official end-of-quarter date. This means the officially monitored portfolios can sometimes differ from the lists published in the magazine. That said, when discrepancies between the two do exist, they are not normally very great. The members of the Long portfolio receive write-ups below while the Shorts are published in the table that follows.
THE LONGS
