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. This is a common misconception. Some investors also 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 some from using it.
What are the main risks associated with dual momentum investing?
One risk is that past history is unreliable, 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 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.
The are now a number of quantitative investment models. What distinguishes GEM from the others?
Many other models are multi-parameter and overfit a limited amount of data. These are not as likely to hold up on a real-time basis. GEM is simple, logical, and based on momentum testing back to at least the early 1800s. GEM has also held up well out-of-sample. See here.
Should one invest using your papers’ momentum portfolios?
My papers are 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 individual risk preferences. Be aware 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 no longer looks as attractive as broader-based dual momentum models like GEM. Using data back to 1801, Geczy and Samonov (2015) show that momentum with geographically diversified stock indices outperforms momentum with sectors, as well as individual stocks, currencies, bonds, and commodities. This may be because home country bias keeps investors from investing as much as they could in more attractive geographic areas thus creating abnormal profits for those who do.
What about adding regions, REITs, gold, or commodities 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 assets such as these.
What about using emerging markets as a separate asset within 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 to sell more volatile assets like EMs during times of crisis.
MSCI EM index data begins in December 1988. Using that data, I used to include EMs as an additional asset (with a 25% of equity limit) in my proprietary enhanced GEM model. Later we acquired additional EM data back to 1950. When we added the additional EM exposure to GEM over this longer period, the drawdowns and volatility were unacceptably high. EMs performed well in the late 1980s and early 1990s. But with more data, additional EM exposure is no longer attractive on a risk-adjusted basis. As with sectors, this shows the importance of longer data sets.
Is it better to use a combination of lookback periods rather than a single one?
It depends. There are tradeoffs that need to be considered whenever you add complexity to a model. See here for more on this.
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 between stocks and bonds 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-term 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 our models have been out of stocks. See here for more on why long-term bonds are not such 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 do better with shorter lookback periods. My enhanced GBM model, therefore, uses different parameters than GEM. Enhanced GBM is now 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 about about using leading economic indicators, such as the unemployment rate, to predict recessions and time stock market exposure?
There are 16 major leading economic indicators. With so many to choose from, it is not hard to put together indicators that look good in hindsight. The unemployment rate may have been useful as a stock market timing indicator back to 1970. But it gave worse results than the trend alone before then.
The stock market is also a leading economic indicator. It gives fewer false signals for timing market exposure and does a better job of identifying bear markets not tied to recessions. There are data snooping, selection bias, and model overfitting issues when you have additional indicators or parameters. Here is an example of several economic indicators that look good in recent years but do not hold up so well long term.
What are the differences between your published and proprietary models?
The proprietary models we license to advisors and family offices use multiple lookback periods chosen to make the models more adaptive. Our proprietary models also apply dual momentum to the bond market where it has also worked well. In addition to enhanced GEM, we also have balanced and conservative proprietary models to accommodate different risk preferences.
What other investments strategies could be a good diversifier for dual momentum?
Those who want to reduce the short-term volatility and the systematic noise of GEM might want a modest permanent allocation to short or intermediate-term bonds as suggested at the end of chapter 8 in my book. To reduce trend-following tracking error, one could have a modest permanent allocation to an S&P 500 or All-World equity index fund. Better still would be a modest allocation to a relative momentum strategy switching between U.S. and non-U.S. equity index funds.
Another way to do this is by allocating to a non-correlated investment strategy. We have a proprietary short-term mean-reversion trading model for this purpose.
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 market 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 ETF.
What about adding value, growth, quality, low volatility, equal weight, or small-cap ETFs to GEM?
They do not improve GEM’s results. Even if they did, we would be cautious of them. Factor-based funds are often subject to data mining and selection biases in their construction. Real-time results from many factor-based funds have 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 mentioned in the reviews of my book and on the internet. Two of them are here and here. If you are still skeptical, you can do your own backtesting with ETFs or mutual funds using Portfolio Visualizer. You should use an S&P 500 fund to determine “single absolute momentum.” Results there are approximate and different from what we get if you use mutual funds there.
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 with the S&P 500 in order to be all-inclusive and to avoid selection bias. Selection 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 that has had 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 signals you would need to deduct 30% of dividends from U.S. indices 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 your taxes or other expenses.
Are there any websites you recommend that provide dual momentum signals?
These websites impose their own ideas without good reasons for their changes. You can easily determine the signals yourself with the information in chapter 8 of my book. Alternatively, you can use a free Morningstar or ETF Screen portfolio to determine the proper signals.
Have you looked at whether there is a best time of the month to rebalance your portfolios?
Studies here, here, and here 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. Rebalancing during that time frame has shown the best results with our models. Here are the Sharpe and Sortino ratios for GEM based on the trading day of the month.
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.
Why do you use Treasury bills with the S&P 500 to determine absolute momentum?
The idea behind absolute momentum is to look at the return of the S&P 500 above the risk-free return. If the risk-free return is greater you stay in bonds until stocks show a positive excess return. There is no reason to bear the risk of stocks when you could earn a better return without volatility.
It looks like the GEM model has underperformed 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 is over a full market cycle.
You also need to understand why GEM has outperformed over the long run. First, are the 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 has been no opportunity for absolute momentum profits. It is difficult for any trend following approach to keep up with the stock market when it is so strong.
You could say that GEM has lost its effectiveness if you believe U.S. stocks will always outperform non-U.S. stocks or there will never be another bear market. 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.
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. Long-term capital gains are taxed at a historically low rate now but it may be higher when ETF investors realize their profit. Many investors also don’t know that over 40% of the long-run return of the S&P 500 comes from dividends. These are taxed whether or not they are earned in an ETF. Those who want to defer all income, including interest and dividends, can do this by investing through a low-cost Nationwide or Fidelity variable annuity.
Why does a subscription site that tracks quantitative models show a lower return for GEM?
They use net rather than gross returns for non-U.S. index data. Net returns have a 30% reduction in dividends to account for foreign tax withholding. This puts GEM at a disadvantage to models that are not invested in foreign ETFs. If you are going to account for taxes, you should do so with all indices and ETFs instead of penalizing models that invest globally.
The main reason for the difference though is their use of MSCI EAFE rather than MSCI ACWI ex-U.S. They say there is little difference between the two. But ACWI ex-U.S. contains 24% more of the world’s market capitalization by including emerging markets and Canada. Using MSCI EAFE instead of MSCI ACWI ex-U.S. decreases diversification and lowers GEM’s return by 130 bps annually since MSCI ACWI ex-U.S. became usable in 1989. This site does not penalize other models accordingly. They are able to use emerging market ETFs and indices.
I read a paper where they use an ensemble mix of lookback periods from 1 to 18 months. What do you think of this?
Because you can use ensemble methods to look at many things at once does not mean you always should. Tobias Moskowitz, a top momentum researcher, said, ”Momentum is a phenomenon that exists at 6 to 12-month horizons. Beyond 12 months, momentum wanes…” Most academic papers on stock momentum use lookback periods of 6 or 12 months. For stock market investing, research results do not support lookback periods shorter than 3 months or longer than 12 months. The ensemble method you mention also shows a fall-off in results using lookbacks under 3 months and over 12 months.
There is modest benefit in using a modest number of lookback periods. We use a few ourselves in our proprietary models, but our research shows better results basing lookbacks on factors other than just time. Incorporating exogenous factors or different trading approaches makes more sense than using a wide array of highly correlated lookback periods.
Also, you cannot correctly judge the probability of something happening after it has already happened. You have to look at results out-of-sample. A 12-month lookback has more out-of-sample validation than any other lookback period. It was first introduced by Cowles & Jones in 1937 and validated by Jegadeesh & Titman in their seminal 1993 study. Other examples are in this blog post, including validation back to the year 1223.
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 whereas a 60/40 stock/bond portfolio returned only 2.5%.
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 tactical approaches.
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 tactical approaches.
Shleifer and Vishny (1997) show that asset managers are afraid of strategies that deviate much from their benchmarks because investors may leave following periods of underperformance. Home country bias is also a strong disincentive to invest this way. It keeps investors from having as much with non-U.S. stocks when they are stronger than U.S. stocks.
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 lookback periods for your models? Won’t shorter lookback periods get you in and out of the market sooner?
Academic research shows that over the long run, momentum for stocks works best with a lookback period of 3 to 12 months. Longer lookback 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, 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 the news 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 back to the beginning of stock trading in the 1600s and to 1223 with other assets 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 apply relative momentum 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. 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.
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 lookback period. With absolute momentum, you compare the current price to the price at the beginning of the lookback period.
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 backtested 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 say 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. By doing so, you may occasionally be in aggregate bonds when the trend in U.S. stocks is down even when non-U.S. stocks are the strongest asset. On page 101 of my book, there is a flowchart that applies relative momentum before absolute momentum for those who prefer doing that.
Do you apply absolute momentum before you apply relative momentum or afterward?
See my answer to the above question. I always apply absolute momentum before using relative momentum.
What about using stop-losses with dual momentum?
Stop-losses were once thought to reduce return whenever they reduced risk exposure. Recent research shows that stops can 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 do not add value 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 considerable profits. This one of the reasons 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? And what about using margin?
Most leveraged ETFs use daily resets which make them best suited for day trading. Daily resets are also not tax-efficient since leveraged ETFs give mostly short-term capital gains and losses.
Our models are designed to be in tune with major market movements. There is still considerable short-term volatility with dual momentum. Intra-month drawdowns close to 20% have occasionally occurred, and larger ones may happen in the future. Investors should consider this carefully before using 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 the highest long-run risk premium. Shorting stocks is, therefore, climbing an uphill battle. We want every advantage we can get by having the equity 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 3 basis points, while the expense ratio of an S&P 500 inverse ETF can be 89 basis points or higher.
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 chart in the previous answer. Strong home country bias keeps investors from investing as much as they might otherwise invest in non-U.S. stocks. We do not have 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 recently, it might make sense to wait a bit to avoid possible short-term mean reversion pullbacks. Otherwise, because everyone has different risk preferences, it is really an individual decision.
Do you have to wait until the next day to trade after you get your signals?
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.
There is a dual momentum ETF using a large number of lookback periods and frequent rebalancing. What do you think of it?
I wouldn’t pay 87 bps per year to invest in a fund that is likely to give a before-costs return that is no higher than one can get from GEM. This ETF promises more consistency than simple dual momentum. But diversifying with non-correlated assets should be more effective than relying on highly correlated lookback periods for diversification. My proprietary models incorporate other factors that help give a higher expected return than GEM with consistency.
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. Stock indices have historically given the best returns.
How has dual momentum done when applied to the bond market?
Dual momentum has done well when used with bonds. We apply dual momentum to bonds in our proprietary models. But it can be more complicated than stock momentum. The lookback periods are different, and there are more sectors to evaluate. This requires more due diligence. That is why we suggest GEM investors use only aggreagte bonds.
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 in bonds less than 30% of the time. Bonds have been responsible for only 20% of GEM’s profits.
Aggregate bonds have an average duration of around 6 years. They are not as sensitive to interest rate changes as longer duration bonds. Over sixty percent of their holdings are government debt. The remaining bonds are investment-grade spread out over 6800 holdings. This means their credit risk is minimal. As the chart below shows, their returns have been relatively steady under varied market conditions. 
Absolute momentum exits equities and enters bonds when it first identifies a bear market in stocks. This often happens just before or early in a recession. This usually leads to falling interest rates as aggregate demand lessens and the FED favors lower interest rates. When stocks are weak, there is also a tendency for investors to move their capital from stocks to bonds. This also increases the demand for bonds.
Our models aim to be totally in bonds only when stocks are in a bear market. 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 government bonds or Treasury bills without a lot of reduction in expected performance.
