My blue-chip momentum screen has had a poor year. Not only have the "long" momentum picks (based on the 10 best-performing FTSE 100 shares of the past three months) underperformed the FTSE 100, but the shorts (the 10 worst performers), have outperformed rather than lagging the index as they are, in theory, supposed to do. To be fair, the past three months have shown an improvement on the year as a whole because the longs have at least outperformed the shorts, even if the index beat both portfolios (see table).
| LONGS | SHORTS | ||
|---|---|---|---|
| Name | Capital Return (15 Sep - 7 Dec 2015) | Name | Capital Return (15 Sep - 7 Dec 2015) |
| Carnival | 3.2% | Fresnillo | 18.9% |
| Mondi | 1.5% | Randgold Resources | 17.4% |
| Taylor Wimpey | 0.3% | GKN | 7.0% |
| International Cons. Airlines | -0.8% | BP | 3.9% |
| easyJet | -2.2% | Aberdeen Asset Mgmt | -4.0% |
| Persimmon | -5.4% | Rolls Royce | -15.1% |
| Barratt Developments | -6.0% | Weir | -16.7% |
| Sports Direct International | -7.6% | Standard Chartered | -27.6% |
| Hikma Pharmaceuticals | -9.3% | Glencore | -32.2% |
| RSA Insurance | -13.8% | Anglo American | -49.3% |
| Average | -4.01% | - | -9.78% |
| FTSE 100 | 2.16% | - | 2.16% |
Source: S&P CapitalIQ
As with all the screening strategies I follow in the column, disappointing periods need to be seen in the round. One of the pleasures of having followed a strategy for as long as I’ve tracked my blue-chip momentum screen is that it is possible to give some longer-term perspective based on the 35 three-month performance periods I’ve monitored from the start of the bear market in mid 2007. What’s more, seeing as another year is drawing to a close, it seems an apt time for a bit of reflection.
To put this year’s disappointment in context, while 2015 has been a bad year (with the longs off 4 per cent, the FTSE 100 up 1.4 per cent and the shorts 5.7 per cent ahead), the two-year performance of the strategy is not quite so tragic. Indeed, over two years the 0.6 per cent return from the longs is superior to the –4.9 per cent from the index, although, it is still shy of the 2.5 per cent return from the shorts.
Longer time periods bring the results from the strategy in line with momentum-investing theory, which says buying the market's best-performing shares and selling the worst-performing will deliver profits. Indeed, over three years the longs are up 26.3 per cent, the index is up 4.1 per cent, and the shorts are down 5.2 per cent. Meanwhile, over five years the longs are 18.9 per cent ahead, the index is ahead by 4.8 per cent and the shorts are down by 15.4 per cent. None of these figures account for dealing charges (generally regarded by academics as the thorn in momentum’s side) or the impact of dividend payments.
Combing through the data from the last eight and a half years reinforces the view that the reliability of a blue-chip momentum strategy in delivering outperformance increases with longer time periods. Indeed, the longs have outperformed in all of the 15 five-year periods I’ve tracked (see bar graph). This may not be too surprising to those who are already fans of momentum or those who have pawed over the academic research on the subject. But while the extent of the data I've collected is undeniably glib compared to some of the extensive historic academic studies carried out into momentum investing, I think it is nevertheless interesting to see the phenomenon in action in real time - as it were.
Longs
Shorts
The relationship between the time period the strategy is monitored over and the likelihood of outperformance is broken down further in the table below. The performance relative to the index is calculated as the difference in the return of the momentum strategy relative to the index return. So was the momentum strategy to hold its value whilst the index fell 50 per cent, the outperformance of momentum would be 100 per cent. If the index rose 50 per cent and the momentum strategy rose 100 per cent, then momentum’s outperformance would be one third.
LONGS
| Period | Average outperformance | Periods of outperformance | Periods in sample | Standard deviation |
|---|---|---|---|---|
| 5 years | 45% | 100% | 15 | 19% |
| 3 years | 29% | 96% | 23 | 21% |
| 2 years | 12% | 89% | 27 | 19% |
| 1 year | 9.4% | 74% | 31 | 12% |
| 6 months | 4.7% | 64% | 33 | 9% |
| 3 months | 2.2% | 62% | 34 | 7% |
SHORTS
| Period | Average out/underperformance | Periods of outperformance | Periods in sample | Standard deviation |
|---|---|---|---|---|
| 5 years | -3.3% | 67% | 15 | 17% |
| 3 years | 0.1% | 61% | 23 | 20% |
| 2 years | -7.5% | 56% | 27 | 25% |
| 1 year | 1.1% | 42% | 31 | 20% |
| 6 months | 1.2% | 52% | 33 | 20% |
| 3 months | 0.4% | 47% | 34 | 13% |
Source: Thomson Datastream, S&P CapitalIQ, IC
I’ve also included standard deviations in the table. Questions about the quality of data aside, statisticians would expect the relative performance of the strategy to be within one standard deviation of the average 68 per cent of the time and to be within two standard deviations 95 per cent of the time. As my numbers are based on fairly limited data, these standard deviation numbers can be regarded as being pretty ropey. However, what is interesting about the numbers is that the standard deviation for the short strategy is massive compared with the average index-relative performances. This helps confirm my gut feeling that using momentum as the primary basis for shorting can be very treacherous. The fact that the results from the shorts have tended to deviate so massively from the average on the downside as well as the upside also give credence to the old saying “don’t catch falling knives”.
Indeed, the stock-by-stock performance of the 15 September short selection (in the table at the start of the article) provides a clear example of the dilemma. While precious metal miners rebounded handsomely during the period, those companies digging base metals from the ground continued to be pummelled.
How The Momentum Screen Works ■ The 10 best performing FTSE 100 shares of the previous three months are selected as the longs. After three months the process is repeated. ■ The 10 worst performing FTSE 100 shares of the previous three months are selected as the shorts. After three months the process is repeated |
This quarter, the short picks seem be clustered around some key themes which raises the likelihood that we could see some extreme performance (either good or bad) from the selection. The most obvious theme would seem to me to be the outlook for China and the implications for the broader Asia Pacific region, especially in light of expectations that Fed will now finally nudge up US interest rates. Short picks that could be affected by changes in sentiment towards China range from miners, to banks, to luxury goods companies. Themes among the longs meanwhile are less easy to pick out.
The 10 long and 10 short picks for this quarter are presented in the tables below. Due to the timing of publication of the magazine the picks do not represent a full three-month performance period. Future assessments of the performance of this strategy will be based on a full three-month period, which means some of the momentum picks may be different from those published below.
THIS QUARTER'S LONGS
| Name | TIDM | Price | Mkt Cap | Fwd NTM PE | DY | Momentum 15 Sep - 7 Dec 2015 |
|---|---|---|---|---|---|---|
| Hargreaves Lansdown | HL. | 1,494p | £7.0bn | 38 | 2.2% | 24.9% |
| Sage | SGE | 614p | £6.6bn | 23 | 2.1% | 22.1% |
| Fresnillo | FRES | 703p | £5.2bn | 39 | 0.4% | 18.9% |
| Randgold Resources | RRS | 4,286p | £4.0bn | 28 | 0.9% | 17.4% |
| Compass | CPG | 1,170p | £19.1bn | 21 | 2.5% | 16.6% |
| Experian | EXPN | 1,216p | £11.7bn | 20 | 2.2% | 16.2% |
| Dixons Carphone | DC. | 482p | £5.5bn | 17 | 1.8% | 15.5% |
| BT | BT.A | 482p | £39.6bn | 15 | 2.6% | 15.5% |
| Associated British Foods | ABF | 3,509p | £27.5bn | 35 | 1.0% | 15.4% |
| Merlin Entertainments | MERL | 430p | £4.3bn | 23 | 1.4% | 15.1% |
THIS QUARTER'S SHORTS
| Name | TIDM | Price | Mkt Cap | Fwd NTM PE | DY | Momentum 15 Sep - 7 Dec 2015 |
|---|---|---|---|---|---|---|
| Anglo American | AAL | 378p | £5.3bn | 8 | 15% | -49.3% |
| Glencore | GLEN | 88p | £12.6bn | 13 | - | -32.2% |
| Pearson | PSON | 783p | £6.3bn | 11 | 6.5% | -31.8% |
| BHP Billiton | BLT | 789p | £41.9bn | 22 | 10% | -28.3% |
| Standard Chartered | STAN | 527p | £13.4bn | 11 | - | -27.6% |
| Meggitt | MGGT | 377p | £2.9bn | 12 | 3.6% | -21.6% |
| Antofagasta | ANTO | 495p | £4.8bn | 28 | 2.9% | -19.9% |
| Rolls Royce | RR. | 599p | £10.9bn | 14 | 3.9% | -15.1% |
| RSA Insurance | RSA | 439p | £4.4bn | 14 | 1.6% | -13.8% |
| Burberry | BRBY | 1,204p | £5.3bn | 16 | 2.9% | -13.5% |
Source: S&P CapitalIQ
My stock screening column will be making way for reviews of the year over the next three weeks. The reviews will cover my annual roster of stock screens, the tips of the week and the tips of the year, which are currently heading for a fifth year of outperformance. The next stock screen to be published will be in the magazine of the 16 January 2015.
