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Momentum wins, value loses

Created:
2 July 2008
Written by:
Chris Dillow

It's a bad idea to buy stocks that offer high yields or have fallen a long way. That's the message of my no-brain portfolios' performance in the second quarter.

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Our high yield portfolio - which comprises the 20 FTSE 350 stocks with the highest dividend yield and the start of the quarter - fell 36.9 per cent in the period, as stocks such as Barratt Developments, HBOS and Trinity Mirror collapsed. It's now lost 57.2 per cent in the last 12 months. Our loser portfolio - the FTSE 350's 20 biggest fallers in the previous three years - has done almost as terribly. It lost 25.8 per cent in Q2, and 56 per cent in the last 12 months.

The performance of all my 'no-thought' portfolios is summarised in the following table. For full details of the equivalent portfolios for the third quarter, including the constituents, you can download the Excel file at the foot of this article.

Portfolio Description Q2 perf. (%) 12M perf. (%)
Mega-cap 20 biggest shares -3.9 -12.1
Small-cap 20 smallest shares -11.9 -33.4
Value 20 highest yielders -36.9 -57.2
Losers Worst over 3 yrs -25.8 -56.0
Low-risk Lowest volatility -8.1 -13.7
Momentum Biggest risers, last 3M -1.9 0.5
High-beta Highest mthly beta, 3 yrs -4.1 -24.7
Idiosync. volatility Highest non-mkt volatility -13.1 -34.0
FTSE350 -2.3 -15.7

Value and loser stocks did far worse than high-beta shares. Our high-beta portfolio only slightly under-performed the market in the second quarter - as one would expect - losing 4.1 per cent compared to the FTSE 350's loss off 2.3 per cent. This suggests that investors have been punished for taking cyclical risk or distress risk, rather than ordinary market risk.

Nor did safe stocks provide a safe haven in the second quarter. Our low-risk portfolio actually under-performed the market, losing 8.1 per cent.

Instead, the winner recently has been momentum. Our momentum portfolio out-performed the market slightly in the second quarter, losing just 1.9 per cent. In the last 12 months, it has avoided the market's woes and has risen 0.5 per cent, whilst the FTSE 350 has dropped 15.7 per cent in the same period.

Momentum is effectively buying shares because everyone else is, so it should come as no surprise to find that commodity stocks are well-represented in this portfolio.

The big question going forward is this: is out-performance of momentum shares the result of investors irrationally under-reacting to good news about shares, or is it merely compensation for taking on risks that happen to have paid off (i.e, the commodity bubble hasn't burst yet).

If it's the latter, momentum could come a cropper eventually.

MORE ON NO-THOUGHT PORFOLIOS...

For details of the third-quarter portfolio constituents, download this Excel file.

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