Frequently Asked Questions
It seems that a lot can happen between the beginning of the month when your momentum indices adjust their positions and the beginning of the next month when new signals are given. Why not check for signals more than once a month?
Research has shown that stock prices are reactive rather than trending over shorter periods of time such as days and weeks. Stocks are more likely to rebound from short-term fluctuations than to continue in the same direction. You will get whipsawed mercilessly if you check for signals frequently. It is best to ignore short term movements and retain a longer term perspective.
If momentum investing is so great why aren’t more people using it?
It usually takes awhile for research to work its way into the investment marketplace. We saw that with indexing. Public awareness should grow as information about momentum becomes more widely accepted over time.
There are also other reasons why momentum investing has not yet caught on. First, it is not as psychologically appealing to buy what has gone up in price as it is to buy things that appear to be cheap. Momentum may also seem too simple to those who think more complex approaches have more merit. Some investors have prejudices against newer styles of investing or investing in indices rather than in stocks. Interestingly, the same behavioral factors that explain why momentum works also explain why momentum has not caught on yet: anchoring, herding, conservatism, and the slow diffusion of information. Dual momentum also has familiarity bias and home country bias that keep others from using it.
What are the main risks associated with dual momentum investing?
One risk is that past history is driven by randomness, and the future may not be like the past. However, there are several hundred years of out-of-sample performance supporting both relative and absolute momentum. There are also behavioral reasons why momentum has a good chance to continue working, since behavioral biases are hard to change.
There is some risk that momentum will attract substantial capital and not work as well in the future because of too many participants. But the broad stock indices we use are more scalable than individual stocks. They are also less popular as momentum investments.
There is risk associated with the trend-following component of dual momentum being slow moving in order to reduce whipsaws. This means that much of the short term volatility of the stock market still exists with dual momentum. Additionally, there are re-entry lags when a new bull market begins after being in bonds during bear markets.
Global Equities Momentum (GEM) model underperformed its benchmarks in 1979-80 and 2009-11. No strategy outperforms all the time. Future drawdowns may be larger than those during the past. Please see our Disclaimer page for additional risk factors.
Should one invest using your papers’ momentum portfolios?
My papers were meant to illustrate the principles of momentum investing and not as models for investing. Data on some markets is limited. REIT index data began in 1972. That is also when the price of gold was allowed to fluctuate. But stocks have traded since the 1600s.
There are some who believe that a widely diversified approach is best. But historically, the highest risk premium has come from equities. Long term research shows that momentum works best when it is applied to geographically diversified stock indices.
How many sectors does your Dual Momentum Sector Rotation (DMSR) model invest in?
The number of sectors depends on one’s attitude toward reward and risk. Fewer sectors mean higher expected returns and higher volatility. You can search for parameters to create a sector rotation model that suits your own risk preferences. Be aware though that data mined parameters may not hold up well out-of-sample.
I show here the performance of DMSR using additional data since my book was published. DMSR is no longer as attractive as broader-based dual momentum models like GEM. Using data back to 1801, Geczy and Samonov (2015) also show that momentum with geographically diversified stock indices outperforms momentum with sectors, as well as individual stocks, currencies, bonds, and commodities.
What about adding small caps, REITs, gold, commodities, or the NASDAQ100 to GEM?
None of these add value to GEM over the long run. As with sectors, their volatility and drawdown are high. Dual momentum does best with moderate volatility. When volatility is too high, you may give up significant profits before you can enter or exit positions. You also do not get compensated enough when you take on more idiosyncratic volatility with narrower assets such as these.
Why don’t you use the U.S. Total Stock Market index instead of the S&P 500?
Results have been better with large cap stocks. This is likely because there is no small cap premium. See here for more on this.
How about using emerging markets as a separate asset with GEM?
EMs are included in the MSCI ACWI ex-U.S. index that we use. They make up 17% of that index based on market capitalization. We feel this is an appropriate amount of exposure. Investors are more prone to panic sell more volatile assets like EMs during times of crisis.
MSCI EM index data begins in December 1988. We recently acquired additional non-MSCI EM data. When we tried adding additional EM exposure to GEM over a longer period, the results were disappointing. Drawdowns and volatility were unacceptably high. As with sectors, this shows the importance of testing on longer data sets.
Why don’t you invest in long-term Treasury bonds when you are out of stocks, since they are negatively correlated?
The negative correlation you see now has not always been there.
Source: Graham Capital Management Research Note, September 2017
Long term bonds also have considerable duration risk. During times of crisis, investors prefer safe harbor assets with little risk of any kind.
Long-term bonds have had similar returns to intermediate bonds despite their higher volatility. This is likely because the return of intermediate bonds includes compensation for reinvestment risk once these bonds mature. Long bonds do not have this reinvestment risk and do not require a premium for it.
Over the past 47 years bonds have been in a bull market much of that time. Even so, long-term bonds have not outperformed short to intermediate term bonds when we have been out of stocks. See here for more on why long-term bonds are not a good safe harbor asset.
I like your Global Balanced Momentum (GBM) model because it holds both stocks and bonds simultaneously. What can I do along those lines?
Bonds behave differently than stocks and can be modeled well using dual momentum. My enhanced GBM model different parameters than GEM. Enhanced GBM is one of the proprietary models I license to investment professionals. To achieve a similar risk profile, you can use the suggestion at the end of chapter 8 of my book and allocate a permanent percentage of your portfolio to short or intermediate-term bonds.
What are differences between your published and proprietary models?
Our proprietary models adapt more to market conditions. Some of them are balanced models that apply dual momentum to the bond markets, where it works well. Our proprietary models also have features that manage tax liabilities.
My 401k plan does not include an all country world stock fund ex-US. What can I use?
Most 401k plans include a fund for non-U.S. stocks. You could use that. If your 401k has an emerging markets fund, you could create a synthetic ex-U.S. all country world fund by allocating 15-20% to the emerging market fund and 80-85% to a non-U.S. developed markets fund. Your signals could still be derived from an ex-U.S. all country world stock fund.
What about adding value, growth, quality, low volatility, momentum or other factor funds to GEM?
They do not improve GEM’s results. Even if they did, I would be suspicious of them. Factor-based funds are often subject to data mining and selection bias in their construction. Real time results from many factor-based funds has not been encouraging. This may get worse in the days ahead as the amount of capital in factor-based funds continues to grow. See our blog posts here and here.
Are there any outside validations of your GEM model?
There are a number of them. One is by TrendXplorer. You can also do your own back testing with ETFs or mutual funds at Portfolio Visualizer to approximate GEM. You should use an S&P 500 fund to determine “single absolute momentum.”
I’ve seen dual momentum signals on the internet where they use an MSCI EAFE ETF rather than an MSCI ACWI ex-U.S. ETF. What do you think of that?
I use the All Country World Index ex-US along with the S&P 500 in order to be all inclusive and to avoid selection bias. Selection is bias is where you select a subset of the data in order to make your results look better or worse. EAFE omits Canada and emerging markets which represent a significant 24% of the world’s equity markets. Holding all else constant, GEM earned 130 basis points more in annual return using MSCI ACWI ex-U.S. rather than MSCI EAFE from when ACWI ex- U.S. was created by MSCI in late 1988. I see no reason to invest with MSCI EAFE having considerably lower returns than MSCI ACWI ex-U.S.
Why do you backtest on index data instead of ETF or mutual fund data?
A major reason is that index data has a lot more history. Another is that non-U.S. stock ETFs and mutual funds (as well as index data using net returns) withhold 30% of their dividend income for foreign taxes. These are often recoverable by investors as a tax credit. Even if they were not, to get accurate relative strength you would also need to deduct 30% of dividends from U.S. Indicies or ETFs.
Expense ratios can also distort the relative performance between assets. Momentum should be based only on asset performance. The markets do not care about taxes or other expenses afterwards.
Are there any websites you recommend that provide dual momentum signals?
All the website I am aware of use ETFs based on indices that give poorer long-run results. You can easily get the signals yourself using the information in chapter 8 of my book. Alternatively, you can use a free Morningstar portfolio or PortfolioVisualizer to get the correct signals.
Have you looked at whether there is a best time of the month to rebalance your portfolios?
Studies show that stocks perform best early in the month. This is when institutional investors make changes to their portfolios. Prices then are most representative of their true value. Research shows rebalancing during that time frame has given us the best results with our models.
GEM has had some close signals for switching in and out of stocks. What do you do then?
Our published results are based on month-end closing prices. I have tested using a 50/50 allocation to stocks and bonds when the signal is close. Results are about the same as following the signal exactly. To reduce feelings of regret no matter what happens, you may want to use this approach. Another possibility is to wait a few days and see which way the signal goes.
It looks like the GEM model under performed the S&P 500 after 2009. Is momentum still effective?
Dual momentum has a trend following component that lags behind when a new bull market begins.That is the cost of avoiding the carnage of the preceding bear market. It is unfair to look only at a new bull market without also considering the preceding bear market.You need to consider at least a full market cycle to make a proper evaluation of performance. GEM has outperformed its benchmark portfolio since 2008 which includes full market cycle.
You also need to understand why GEM has outperformed over the long run. First, are its profits from switching between U.S. and non-U.S. stocks according to relative momentum. Since 2009, U.S. stocks have continuously outperformed non-U.S. stocks, so there have been no opportunities for relative strength profits. Second, the current bull market has been one of the longest in history. This means there have also been no opportunities for absolute momentum profits. It is difficult for any trend following approach to keep up with the stock market when it is so abnormally strong.
You could say that GEM has lost its effectiveness only if you believe U.S. stocks will always outperform non-U.S. stocks or that there will never be another bear market. Finally, if GEM underperforms over shorter periods of time, dual momentum investors are willing to accept that because of the drawdown protection it has shown during severe bear markets.
Since there is no dual momentum ETF, how tax efficient is GEM?
Since 1971, 73% of GEM’s gains have been long-term, while nearly 100% of its losses have been short-term. Many investors don’t know that over 40% of the long-run return of the S&P 500 has come from dividends. These are taxed whether or not they are earned in an ETF. You can defer all income, including interest and dividends, by investing through a low-cost Fidelity variable annuity.
Stock valuations look now high, and bond yields are low. Will this adversely affect dual momentum returns?
High stock valuation levels can mean lower expected stock returns, and low bond yields usually point to lower future bond returns. But stocks and bonds still fluctuate and can create opportunities. In 2000, there were also high stock market valuations and low bond yields. But our GEM model had a compound annual return of 11.6% over the next 10 years when a 60/40 stock/bond portfolio returned only 2.3%.
Past performance is, of course, no assurance of future success.
The stock market is up a lot this past year. Is there more risk if I get started now?
The stock market is subject to V-shaped, panic-induced bottoms. But tops are often a different story. It often takes awhile for them to form as bulls and bears battle for dominance. By the time this happens, absolute momentum can catch up with prices so that stock market exits are not so far away from market tops. You can see evidence of that by looking at the GEM charts on our Performance page.
Will dual momentum will lose its effectiveness if more people start using it?
Any anomaly can lose profitability if it becomes too widely followed. However, the behavioral basis behind momentum is strong and persistent. Human nature does not readily change.
The same biases that make dual momentum work also keep investors away from it. This is especially true of institutional investors who often have an aversion to any kind of tactical approach. Shleifer and Vishny (1997) also show that asset managers are afraid of strategies that deviate from their benchmarks because investors may leave following periods of underperformance. Home country bias is also strong one. It keeps investors from having as much as they should with non-U.S. stocks when stronger than U.S. stocks.
In aggregate, the performance of actively managed funds is inferior to passively managed funds. People have known about that since the 1960s. Yet over 70% of all domestic equity funds are still actively managed. Dual momentum investing may very well show the same disconnect.
How do you determine the best look back periods for your models? Won’t shorter look back periods get you in and out of the market sooner?
Academic research shows that over the long run, momentum for stocks works well with a look back period of 3 to 12 months. Longer look back periods minimize transaction costs and increase the likelihood of long-term capital gains.
A 12-month look back was found to work well by Cowles & Jones in 1937. It has held up well ever since. Staying with this look back period reduces concerns about data mining and seasonality bias.
While shorter look backs may get you out of and back into markets sooner, they can produce more whipsaw losses. This actually leads to lower returns and larger drawdowns. A 3-month look back worked well with GEM until 1979-1980. Overall since 1971, a 12-month look back has performed better. See our blog post “Perils of Data Mining” for more details.
Some investors skip the last month when applying momentum. Why don’t you do that?
It makes sense to skip the last month when you are applying momentum to stocks because individual stocks often overreact to news and then mean revert. If you use stock indices or other asset classes like we do, you do not need to skip the last month.
Why do you use momentum with stock indices instead of individual stocks?
See here for why we prefer to use momentum with indices instead of stocks. According to this study, stock momentum profits have been insignificant since 1999. According to another study, momentum profits disappeared in the early 1990s. For more on stock momentum, see our review of the book Quantitative Momentum.
Why does the performance of GEM begin in 1950 on your website but in 1974 in your book?
We were constrained by the lack of non-U.S. stock index data when I wrote my book. The additional data we acquired since then has validated the outperformance of GEM. In addition, both relative strength and absolute momentum were found to outperform buy and hold when tested back to 1801 by Geczy & Samonov (2015). Absolute momentum showed superior returns and less downside risk all way back to 1223 in Greyserman & Kaminski’s book.
Isn’t value investing the opposite of momentum investing? How can both be valid?
Value and momentum operate on different time frames. Value is based on longer-term mean reversion, while momentum relies on intermediate (usually 3 to 12 months) serial correlation.
Why don’t you just use relative momentum applied to stocks and bonds?
Over the long run, dual momentum performs better. Historically, stocks provide the best returns. So we want to be in them as long as their trend is positive. The best way to determine that is absolute momentum. Once we decide to be in stocks, we use relative momentum to tell us whether to be in U.S. or non-U.S. stocks.
Do you use Sharpe ratios to evaluate systems’ performance?
Volatility will be lower and Sharpe ratios higher for strategies that hold bonds. It makes more sense for us to look at compound annual growth rates (CAGR). CAGRs incorporate volatility in a more realistic way than Sharpe ratios, which divide average excess return by volatility. Sharpe ratios are also not a good indicator of downside risk exposure, especially when returns are non- normal. Some look at worst drawdown to judge downside risk, but that is only one point in time. We prefer to look at the distribution of drawdowns along with CAGRs.
Why do you use absolute momentum for trend following instead of moving averages?
With moving averages, you compare an asset’s current price to an average of prices over the look back period. With absolute momentum, you compare the current price to the price at the beginning of the look back period. This makes moving averages signals are more sensitive. They produce more trades than absolute momentum over the same look back periods. Absolute momentum thus has lower transaction costs, as well as fewer false signals and whipsaw losses.
Zakamulin shows that absolute momentum outperforms 3 different types of moving averages on 155 years of stock market index data. Absolute momentum and reverse exponential moving averages are the only two methods that outperform the market with statistical significance.
When I back tested GEM there were some months in which GEM was in foreign stocks. You show GEM in aggregate bonds. Why is that?
On page 98 of my book. I mention that I first determine absolute momentum using the S&P 500 index, since the U.S. leads world equity markets. I also cite a supporting reference. If you calculate absolute momentum first, you may occasionally be in aggregate bonds if the trend in U.S. stocks is down even when non-U.S. stocks are the strongest asset.
What about using stop-losses with dual momentum?
Stop-losses were once thought to reduce return when they reduced risk exposure. Recent research shows that stops can actually enhance returns if they are used with care. I have a blog post that discusses this. We found dual momentum more effective than stop losses in reducing risk exposure and enhancing expected return. Stops are redundant and unnecessary when using dual momentum.
Since momentum works best geographically, why not use it with individual country ETFs?
Dual momentum works best when volatility is not too high. Individual countries can have extreme volatility. This can make it difficult to get in and out using trend following momentum without giving up a lot of profit. This is the same reason we do not use small cap indices or stock sectors. Additionally, country index funds can have lower liquidity and higher bid-ask spreads than broad-based index funds. This can create the same potential price impact and scalability issues as momentum applied to individual stocks.
How do leveraged ETFs perform with dual momentum?
Most leveraged ETFs use daily resets which make them best suited for day trading. There can be large tracking errors when holding leveraged ETFs on a longer term basis. Daily resets are also not tax efficient since leveraged ETFs give mostly short-term capital gains and loses. Finally, leveraged ETFs usually have a leverage factor of 2X or greater. That may be too much leverage. There is still considerable short-term volatility with dual momentum that may cause discomfort with 2X or greater leverage.
Have you looked at inverse equity instead of using bond ETFs when absolute momentum
tells you to exit stocks?
Equities are the core of our models because they have highest long-run risk premium. Shorting stocks is therefore climbing an uphill battle. We want every advantage we can get by having risk premium on our side to serve as a tailwind for future performance.
There are also higher costs associated with inverse ETFs. You can own an S&P 500 ETF for an annual expense of 4 basis points, while the expense ratio of an S&P 500 inverse ETF can be 89 basis points.
Because stocks have an upside bias and our models are slow moving, there is often not much profit from short positions by the time you enter and exit. The average bull market since 1942 has lasted 32 months, while the average bear market has lasted only 12 months. Switching to bonds during stock market weakness identified by dual momentum has historically done better than being short stock indices.
There are international stock index ETFs that hedge their currency exposure. What about using these with GEM?
There is a tendency for international stocks to outperform U.S. stocks when the U.S. dollar is weak and non-U.S. currencies are strong. This lets us profit from the strength in non-U.S. currencies. When non-U.S. currencies are weak, GEM is usually out of international stocks. There is thus little reason to use hedged ETFs. GEM automatically deals with and takes advantage of exchange rate exposure.
Is international diversification still beneficial now that more companies are globalized?
Low correlation across global stocks is not the main source of our relative momentum profits. The benefits come more on a global macro level from performance differences between the U.S. economy (reflected in the strength or weakness of the U.S. dollar) versus the rest of the world. See the above chart. Strong home country bias keeps investors from investing as much as they should in non-U.S. stocks when they are strong. We are able to exploit that bias.
What is the best way for non-U.S. Based investors to use dual momentum?
We have a blog post called “Dual Momentum for Non-U.S. Investors” that discusses this in detail.
Is it better to scale into dual momentum or to invest all at once?
If stocks have been up a lot during the past month or two, it might make sense to wait some to avoid possible short-term mean reversion pullbacks. Otherwise, you are usually better off going all in at once. Because everyone has different risk preferences, it is really an individual decision.
Do you make your buy and sell decisions using month-end prices?
Consistent with most academic work, our models’ entries and exits are based on monthly closes that reflect total returns. If you want to trade the same day as your signals instead of waiting until the next day’s open, you can set up a portfolio on SharpCharts that updates real- time during trading hours. You can then get your signals just before the markets close.
What are momentum crashes, and do I need to worry about them?
These are caused by the short side of long/short momentum portfolios suffering large losses when stocks rebound sharply off V-shaped market bottoms. This happened in 1932 and 2009. Since we do not hold short positions, momentum crashes are irrelevant to us.
Can dual momentum be used with markets other than stocks and bonds?
Both absolute and relative momentum have worked well with different asset classes for more than 200 years. But stock indices have historically given the best returns. Short and intermediate term bonds are a good safe harbor when stocks are weak.
With bonds being in a bull market over the past 35 years, does the use of aggregate bonds with Global Equities Momentum (GEM) overstate future expected performance?
GEM has been out of equities only about 30% of the time. Aggregate bonds have been responsible for only 20% of our profits.
Aggregate bonds have an average duration of around 6 years. They are not as sensitive to interest rate changes as longer duration bonds. Their credit risk is also minimal. Seventy percent of their holdings are government debt. The remaining are AAA rated corporate bonds spread out over 6800 bond holdings. As the following chart shows, their returns have been relatively stable and steady under varied market conditions. Their ETFs have the lowest bond ETF expense ratios.
Absolute momentum exits equities and enter bonds when it first identifies a bear market in stocks. This usually happens just before or early in a recession. This often leads to falling interest rates as aggregate demand lessens. When stocks are weak, there is also a tendency for investors to move their capital from stocks to bonds. This also increases demand for bonds.
Our models aim to be totally in bonds only during bear markets in equities. You can see below how intermediate bonds have performed during those times.
We think it is reasonable to accept a little duration risk during bear markets in stocks. If you disagree, you can substitute shorter-term bonds or Treasury bills with only a modest reduction in overall performance.
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