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.
Research has shown that stock prices are reactive rather than trending for shorter periods of time, such as days and weeks. Stocks are more likely to rebound from short-term fluctuations than continue in the same direction. It is usually better to ignore short term movements and retain a longer term perspective.
If momentum investing is so great, why aren’t more people doing it?
It usually takes awhile for academic research to work its way into the investment marketplace. We saw that with indexing and value investing. Public awareness should grow as information about momentum gets better assimilated over time.
There are also other reasons why momentum investing has not caught on. First, it is not as psychologically appealing to buy things that have already gone up in price as it is to buy things that appear to be cheap. Second, momentum may seem too simple to some people who are think more complex approaches have more merit. Finally, some investors have strong prejudices toward other styles of investing.
Interestingly, the same behavioral factors that explain why momentum works can also explain why momentum has not caught on yet: anchoring, conservatism, and the slow diffusion of information.
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 now several hundred years of out-of-sample performance supporting momentum. There are also strong behavioral biases contributing to why momentum has a good chance to continue to work.
There is some risk that momentum will attract substantial capital and not work as well in the future because of too many participants. But stock indices are much more scalable than individual stocks.
Another risk are occasional timing miscues that cause dual momentum portfolio to lag behind its benchmarks. Over the past 40 years, our Global Equities Momentum (GEM) model under performed its benchmark in 1979-80 and 2009-11. No strategy outperforms all the time.
There is also risk associated with the trend-following component of dual momentum being slow moving to minimize whipsaws.This means that much of the short term volatility of the stock market still exists with dual momentum.
There are also re-entry lags when a new bull market begins after dual momentum has taken you out of a prior bear market. Please see the Disclaimer page of this website 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 actual investing. Historically, the highest risk premium has come from equities. Research shows that momentum works best with geographically diversified stock indices.
My book’s GEM model is designed as a do-it-yourself approach using dual momentum focused on stock indices. The section called “How to Use It” in Chapter 8 of my book shows how you can easily implement the GEM model.
How many sectors does your Dual Momentum Sector Rotation (DMSR) model invest in at any one time?
The number of sectors can vary if you use a buffer zone for exits. The number of sectors also depends on one’s attitude toward reward and risk. Fewer sectors mean higher expected returns and higher volatility. You can use the principles in my book to develop a sector rotation model that suits your own risk preferences. However, on a blog post I show that the performance of DMSR using additional data since my book was published is no longer as attractive as the performance of broader-based dual momentum models like GEM. I no longer use sector rotation, nor do I encourage others to use it. Academic research shows that momentum gives the best results with geographically diversified stock indices over the past 200 years. Momentum results with sectors have been worse than with stocks or geographically diversified stock indices.
Why do you update the performance of only your Environmental, Social, and Governance and Global Equities Momentum models now on your website now?
My ESGM and GEM models are publicly disclosed. Anyone who reads my book can easily implement them. My other dual momentum models continue to do well, but are proprietary. I license them to several investment professionals who use them to manage their accounts.
I like your Global Balanced Momentum (GBM) model because it holds both stocks and bonds. What can I do along those lines?
My GBM model is now different from what was published in my book. I license it and my other proprietary models to investment professionals. To achieve a similar effect, you can use the suggestion at the end of chapter 8 of my book and allocate a permanent percentage of your portfolio to aggregate bonds and the remainder to GEM.
My 401k plan does not include an all country world stock fund. What can I use instead?
Most 401k plans include a fund for non-U.S. developed market stocks. You could use that instead. To get better expected returns, if your 401k has an emerging market fund, you could create a synthetic ex-U.S. all country world fund by allocating 25% to an emerging markets fund and 75% to a non-U.S. developed markets fund. Your signals could then be derived from an ex-U.S. All country world stock fund.
Have you tried adding value, quality, low volatility, momentum, or small cap stock indices to your GEM model?
They do not improve the results. Even if they did, I would be suspicious of them for two reasons. First, most are subject to data mining and selection bias in their construction. Second, real time results from factor-based investing has been disappointing due to price impact and other real world influences. This is expected to get worse in the days ahead as the amount of capital in factor funds increases. See “Factor Zoo or Unicorn Ranch?”
Are there any outside validations of your GEM model?
Have you looked at whether there is a best time of the month to reevaluate and rebalance your portfolios?
There are minor performance differences based on what day you use. These may just be normal data noise. Rebalancing around month-end has given good past results. It is important to stay with whatever day you decide to use and not be swayed by emotion to change your signals dates.
During the past year, GEM has had some close signals for switching in and out of stocks. Is there some rule of what to do when this happens?
All 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. This does not make much difference in long run risk-adjusted returns. To reduce feelings of regret no matter what happens, you may want to use this approach.
It looks like the GEM model has under performed the S&P 500 since 2009. Has momentum lost its effectiveness?
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 the new bull market without also considering the preceding bear market.You need to look at a full market cycle at least to make a accurate evaluation of performance. GEM has outperformed an appropriate benchmark portfolio since 2008 and earlier.
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. Secondly, the current bull market has been one of the longest in history, so there have 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 abnormally strong.
You could make a case that GEM has lost its effectiveness if you believe U.S. stocks will always outperform non-U.S. stocks and that there will never be another bear market. Finally, even if GEM underperforms over shorter periods of time, many investors are willing to accept that because of the drawdown protection it has given during bear markets.
Has the FED policy keeping interest rates low for so long had any effect on dual momentum profitability?
Quantitative easing and low interest rates have helped boost stock returns. This is now the second longest bull market ever in stocks.When there are abnormally positive returns in stocks, it is difficult for any trend following approach that exits the market occasionally to keep up with it.
Since there is no ETF for dual momentum investing, how tax efficient is it?
75% of the gains from GEM have been long-term, and 100% of the losses have been short-term. What many investors don’t realize is that over 40% of the long-run return of the S&P 500 has come from dividends. These are taxed at ordinary income rates whether or not they are earned in an ETF. What investors should pay attention to is the expected return they end up with after taxes, as well as the drawdowns they will have to experience along the way.
Stock valuations look high now, 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 point to lower future bond returns. But stocks and bonds still fluctuate and can create opportunities. In 2000, there were also high stock valuations and low yields. But our GEM model had a compound annual return of 11.6% over the next 10 years, while a 60/40 stock/bond portfolio returned 2.3%
Chart courtesy of SharpeReturns.ca
Will dual momentum will lose its effectiveness when more people start using it?
An anomaly can certainly lose profitability if it starts being widely followed. However, the behavioral basis behind momentum has been strong and persistent. Human nature does not readily change, and so I expect the momentum effect to continue to persist.
It is unlikely that most people will become dual momentum believers. Many have been brought up as value or buy-and-hold investors. Their biases may keep them from ever adopting dual momentum.This is especially true of institutional investors who often have a strong aversion to any kind of tactical allocation. Even if this were not the case, Shleifer and Vishny (1997) show that asset managers are afraid of strategies that deviate from their benchmarks because investors may leave them following periods of under performance.
In aggregate the performance of actively managed funds is inferior to passively managed funds. People have known about that for many years. Yet over 70% of all domestic equity funds are still actively managed. 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 into and out of the markets 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.
While shorter look backs may get you out of and back into markets sooner, they can produce more whipsaw losses and can actually lead to lower returns and larger drawdowns. A 12-month look back period was found to work well by Cowles & Jones in their 1937 momentum study. It has held up remarkably well ever since and is commonly used in other academic research. Staying with this look back reduces concerns about data mining.
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 can overreact to news and mean revert. If you want to use momentum with stocks (not recommended), see our review of the book Quantitative Momentum. If you use stock indices or other asset classes, you do not need to skip the last month. Academic research shows momentum works best with geographically diversified stock indices rather than with individual stocks or with other assets. See Geczy and Samonov (2015).
Why does the performance of the GEM model begin in 1974 in your book and 1971 on your website? Is this enough data to be robust?
When my book was written, the earliest bond index data I could get was from 1973. Now I have additional bond index data, so the GEM performance record on my website goes back to January 1971 where it is now constrained by the lack of data for aggregate non-U.S. stock indices. I can go back to 1927 when looking at U.S. equities with absolute momentum where international stock index data is not needed. See my blog posts, Absolute Momentum Revisited and And the Winner Is… In addition, both relative strength and absolute momentum have been individually tested back to 1801. See Geczy and Samonov (2015).
When I back tested GEM, there were a few months in which I see GEM is in foreign stocks, but you show GEM in aggregate bonds. Why is that?
On page 101 and 112 of my book I give a simplified logic for GEM so anyone can easily implement it using a free charting website. There is a minor difference if you calculate the signals as discussed on page 98 of my book. I mention there that I determine absolute momentum using only the S&P 500 index, since the U.S. leads world equity markets. I cite a supporting reference. This means we 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.
Isn’t value investing the opposite of momentum investing? How can both be valid?
They operate on different time frames. Value is based on long-term mean reversion, while momentum relies on intermediate-term (usually 3 to 12 months) serial correlation. Despite all the attention it has received, there is strong evidence that value investing has not held up well well in the real world. See my factor investing blog post.
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 its 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 means moving averages signals are more sensitive and give more than 25% more trades than absolute momentum. Absolute momentum thus has fewer false signals and whipsaw losses, as well as lower transaction costs.
Zakamulin shows that absolute momentum outperforms 3 different types of moving averages on 155 years of stock market index data. Momentum is one of only two methods that outperform the market with statistical significance.
What about using stop-losses with dual momentum?
Stop-losses were once thought to reduce returns when they reduce risk exposure. Recent research shows that stops can actually enhance returns if they are used with care. I have a blog post called “Momentum and Stop Losses” that discusses this. Dual momentum is more effective than stop losses in reducing risk exposure and enhancing returns. Stops are therefore redundant and unnecessary when using dual momentum.
Since momentum works best geographically, why not use it with country index ETFs?
Dual momentum works best when volatility is not too high. Individual countries can have very high volatility. This can make it difficult to get in and out of them using trend following momentum without giving up much of their profit. This is the same reason we do not use small cap indices or stock sectors. Additionally, country indices often have lower liquidity and higher trading costs.
How do leveraged ETFs perform with dual momentum?
There are drawbacks to using leveraged ETFs. First, most leveraged ETFs use daily resets which are 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 will result in mostly short term capital gains or loses. Finally, leveraged ETFs have a leverage factor of 2X or greater. This 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 using inverse equity instead of bond ETFs when absolute momentum
tells you to exit stocks?
Equities are the core of our models because they have shown the 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. Also, 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 duration since 1942 has been 32 months, while the average bear market has lasted only 12 months. Switching to bonds during stock market weakness as identified by dual momentum has historically done better than being short stock indices.
There are international stock ETFs that hedge their currency exposure. What do you think 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 often out of international stocks. So there is little reason to use hedged ETFs. GEM automatically deals with exchange rate risk.
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. The only idea I would add to it now is that non-U.S. Investors may want to include their home country in their portfolio.
Do you make your buy and sell decisions using month-end prices?
Consistent with most academic work, my models’ entries and exits are based on monthly closing prices 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.
What are momentum crashes, and do I need to worry about them?
These are caused by the short side of long/short momentum suffering large losses when stocks rebound sharply off severe bear market bottoms. This happened in 1932 and 2009. Since we do not hold short positions, momentum crashes are irrelevant to us.
How do you invest your own funds?
I developed dual momentum specifically for my personal investing. Nearly all my liquid net worth is invested with the same proprietary dual momentum models I license to investment advisors for managing their customer accounts.
How are your proprietary models different from the GEM model disclosed in your book?
Like GEM, our proprietary models are simple and robust. But they are more adaptive to market conditions, and they include a few more ETF choices. There are also conservative proprietary models that incorporate dual momentum applied to the fixed income markets.
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?
Aggregate bonds have an average duration of only around 5 years. This means they are not as sensitive to interest rate changes as longer duration bonds. As the following chart shows, their returns have been relatively stable and steady. According to Nuveen, there have been three rising interest rate periods since 1994. Aggregate bond returns have been positive during all three periods. Furthermore, GEM and ESGM have been out of equities only about 30% of the time, and aggregate bonds have been responsible for only 20% of our models’ profits.
Absolute momentum is used to exit equities and enter bonds when it first identifies bear markets in stocks. These usually precede recessions, which often lead to falling, rather than rising, interest rates as aggregate demand lessens and the Federal Reserve tries to stimulate the economy. When stocks are weak, there is also a tendency for investors to move from stocks to bonds, thereby increasing demand for bonds. So it seems prudent to accept a little duration risk then. If you disagree with this, you can substitute shorter term bonds or Treasury bills for aggregate bonds with only a small fall off in performance.
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