Our momentum screen is beating the FTSE 100

For once, this isn’t down to a slump in the pound, as is often the case with an index whose collective earnings are more global than domestic. On a one-year basis, sterling is up both against the dollar and the euro.

And while the S&P 500’s recent rally has again been powered by a clutch of familiar tech giants, the resilience of UK-listed blue-chip stocks appears more broad-based.

Our stock screens, which mainly focus on the upper reaches of London’s equity market, know this well. But as our all-screen performance dashboard shows, few have been able to match their benchmarks’ headline returns of late.

One stockpicking methodology that continues to beat and possibly exploit the FTSE 100’s strength has been our quarterly Momentum Classics screen – up 7 per cent over a year, or 29 per cent over three, all before dividends. By taking long or short positions in recent risers and fallers, the screen aims to replicate the well-documented (though not fully understood) phenomenon of momentum investing, which suggests that what goes up tends to keep going up (until a point, that is).

On paper, the screen is also up against it. In the 64 quarters we have followed the method, the FTSE 100 has climbed in value 62.5 per cent of the time. By comparison, the 10 stocks that rose the most in the preceding three months (which we call the ‘longs’) also rose about 56.3 per cent of the time over the next quarter. The past quarter’s biggest fallers (the ‘shorts’) went up in 54.7 per cent of cases.

That last observation helps explain why shorting is so volatile. Although the shorts are down 7 per cent in simple terms since the screen’s inception, it rarely pays to bet on near-term price declines when markets are buoyant – even when the targets appear to be in the grip of negative newsflow or a protracted price slide.

On a one-year basis, a trader who periodically took short positions in the worst-performing FTSE 100 stocks identified by our quarterly momentum screen would be down 6 per cent before dividends. Over three years, this strategy would have fared even worse, resulting in a 29 per cent loss before both dividends and the charges involved in shorting individual shares for months at a time – a practice that has become increasingly costly as interest rates have climbed higher.

Instead, it is the other side of the coin – namely, the performance of the Momentum Classics’ longs – which is worth emphasising. Over one, three, five and 10 years, the FTSE 100 stocks that did the best in the preceding quarter have, on average, gone on to beat the index over the next. Since we started tracking it in June 2007, the Momentum Classics screen has returned 263 per cent, equal to a simple return of around 8.4 per cent a year before dealing costs and dividends.

Last quarter’s selections again reflected the long-term performance trend.

For one, the longs presciently identified Melrose Industries (MRO) as the subsequent period’s biggest individual riser. The turnaround group, which completed the demerger of the GKN automative, powder metallurgy and hydrogen businesses in the period, made by far the largest contribution to the positive momentum picks, which was otherwise split evenly between risers and fallers.

March’s shorts were, as a bunch, more consistent, although their gains lagged the 3.9 per cent appreciation in the index. Eight of the 10 finished the quarter at a higher price, and there were none of the dramatic dead cat bounces that can make betting on short-term price falls so risky – even if Barclays (BARC) and Glencore (GLEN) saw double-digit rises. Only precious metals miner Fresnillo (FRES) and packaging giant Mondi (MNDI) gave up ground, and then not by much.

Indeed, a rising market tide lifted 62 of the FTSE 100’s boats in the period, a higher proportion than in any quarter since 2021.

Summer selections

There are a couple of things to note about this quarter’s stocks. The first is that the average share price rise in the longs is higher than at any point since March 2022, when the invasion of Ukraine sparked a dramatic upward revision in a raft of resources names. What that means for these stocks’ staying power over the coming months is impossible to say, although as a bunch they are a little more diversified than the last group to average at least a 25 per cent gain in the previous quarter.

This diversification also stretches to geographic considerations, which feels like a useful hedge given the possibility of another dive in UK economic indicators over the summer.

Might this already be brewing? This quarter, UK retailers Kingfisher (KGF) and JD Sports Fashion (JD) have both flipped from the longs to shorts. In both cases, falling share prices appear in part to reflect renewed doubts about the strength of consumer spending – despite surging optimism at the start of 2023. British Land (BLND), which we described as the epitome of the British commercial real estate market in a January sell idea, is another potential short play on fading investor sentiment towards the UK.

Less agreeable – from the perspective of this magazine’s ideas section, at least – is the presence of chemicals group Johnson Matthey (JMAT) and medical technology firm ConvaTec (CTEC) in this quarter’s shorts, although both are within 10 per cent of the prices at which we penned bullish analyses this year.

The same could also be said of the appearance of private equity sector-defying (and fellow Investors’ Chronicle sell idea) 3i (III) toward the top of the list of longs. In recent months, our quibbles with the investment fund’s increasingly heavy weighting to (and associated valuation thereof) the fast-growing European discount retailer Action Group has not been shared by the market, which continued to bid up 3i shares above portfolio net asset value.

Where we have voiced doubts about the capacity of Action to maintain its heady rate of expansion – or the continued support for an 18.5 times cash profit valuation multiple at a moment of rising interest rates and largely shuttered IPO gates – investors in 3i, like the firm itself, have been well-rewarded by sticking with a momentum-led approach.

3i’s stake in Action is now marked at £11.2bn, up 53 per cent in the year to March. The shares are up 84 per cent over 12 months. Can this clip be maintained? In the long term, there are sound reasons for scepticism, although we’ll know more in three months’ time.