How have momentum strategies performed recently?

Mark Hulbert writes that unless you think that the stock market has entered an era of perpetually high volatility, it would be premature to give up on momentum approaches.
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No-Load Fund X is one of the select few newsletters whose model portfolio has beaten a buy-and-hold over the past 40 years.

Its investment approach is remarkably simple: Construct your model portfolio so as to always own the equity mutual funds with the best returns over the recent past. By following that momentum approach, the newsletter has produced a 12.0% annualized return between June 30, 1980, and June 30, 2020, versus 11.2% annualized for the overall stock market (as measured by the Wilshire 5000 index). Both returns reflect reinvested dividends.

It should go without saying that almost all investment advisers fail to beat the market over as long a term as 40 years. Of those newsletters my Hulbert Financial Digest started tracking on June 30, 1980, the vast majority are no longer published today. And of those few that are still published, the vast majority of them have failed to beat a simple buy-and-hold over that four-decade period.

So No-Load Fund X is part of a very small minority.

The newsletter’s strategy was devised in the 1970s, before the much-vaunted momentum effect was hardly even known or documented. It wasn’t until nearly two decades later, in 1993, that the first major study to report on the momentum effect was published in a major academic journal.

Though the newsletter is one of the few to have beaten the market over the long-term, it hasn’t performed as well in recent years as it did in the 1980s and 1990s. This has led some to wonder if momentum approaches no longer are as effective as they once were.

One way to answer this crucial question is to subject the newsletter’s returns to a battery of tests that search for any deterioration in returns that exceeds what you’d expect on the basis of sheer luck and randomness. Those tests came up empty.

Also noteworthy is the correlation between momentum’s success and the market’s volatility. Researchers have found that the approach works far better during periods of lower market volatility. This is relevant because the stock market in recent years has been significantly more volatile than in the 1980s and 1990. Since 2007, for example, the CBOE’s Volatility Index’s VIX average level has been 27% higher than it was in prior years.

This correlation between momentum and market volatility is evident in the accompanying chart, which plots No-Load Fund X’s trailing 12-month return, less that of the Wilshire 5000 Total Return index. The newsletter’s highest 12-month alpha came in early 2000, at the top of the Internet bubble, just before that bubble burst. That was at the end of a period of remarkably low volatility.

Hulbert Chart 072320

This research suggests that, unless you think that the stock market has entered an era of perpetually high volatility, it would be premature to give up on momentum approaches such as the one recommended by No-Load Fund X.

To be sure, there are today myriad different momentum strategies that compete for your attention. But none of them has been continuously offered in real-time for 40 years, and those that report track records back that far are based on back testing — which is statistically suspect. The virtue of the Hulbert Financial Digest’s newsletter tracking is that it shows what No-Load Fund X was able to achieve in real time, reflecting what was known and actionable at each point along the way over the past 40 years.

(Full disclosure: No-Load Fund X is one of the newsletters that pays a flat fee to have its returns audited by my performance-tracking firm. Because all newsletters pay the same flat fee, there is no incentive to make any of the firms come out on top.)