May

4

There is an idea that's pervasive, that has become conventional wisdom in much of the academic and hedgefund community — it is that there is a tendency for the stocks that have been outperforming over the past 3-12 months to persist for the near future in their outperformance. A main source of the idea is the academic papers of Jegadeesh and Titman, published in the mid 90s (Rev. Fin. 1995, Vol 8, 973-993).

This idea, or at least the simple interpretation of it that I test here, has not been working well in recent years among large cap stocks.

For the years 1997-2006, I considered S&P 500 component stocks at year end, requiring a share price (the price as it stood at the time, unadjusted for splits) greater than $10. I calculated the median trailing 1-year return for the qualifying stocks, then separated them into two portfolios, the "Leaders", an equal-weighted portfolio of stocks that had a trailing 1-year return exceeding the median, and the "Laggards", with 1-year returns less than the median. Then I looked at the forward 1-year returns for these portfolios, and for "Hedge", which is "Leaders -Laggards". Here are the portfolio returns by year:

Year  Leaders    Laggards   Hedge
1997     33         26           7
1998     21          7          14
1999     17         12           5
2000      2         25         -23
2001     -5         10         -15
2002     -9        -15           5
2003     30         51         -21
2004     20         16           4
2005     15          6           9
2006     16         18          -2
       
avg      14         16          -2
stdev    14         17          13
t-score   3.1        2.9        -0.4

So the Laggards actually won by a narrow margin.

Maybe there are other circumstances where the Leaders beat the Laggards. Perhaps they do so for small cap stocks, which I haven't tested here. Don't fall prey, though, to the idea that they win pervasively, consistently, or by a wide margin.

Kim Zussman adds:

Prof. Pennington's results fit with the recent literature, including the new article The Disappearance of Momentum by Hwang and Rubesam, that suggest rumors of the death of momentum are not exaggerated, notwithstanding that Jegadeesh's construction was high-low deciles, not halves.

Over the past 10 years, buying stocks based either on momentum or reversion worked equally well. Now, where are those darts?
 


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