These past few months have been a tough time period for anyone investing in the Global Equities Momentum strategy:
Table 1 – Global Equities Momentum Performance Fourth Quarter 2018
|Jan – Dec 2018||-7.75%|
Global Equities Momentum kept investors invested in the stock market during the last quarter of 2018, including during the sharp downdraft in December. Then it signaled them out of the S&P 500 at the beginning of January, just as the market began a sharp rebound.
A typical global asset allocation portfolio* lost -6.06% during 2018, and did 1.69% better than Global Equities Momentum.
Additionally, if investors used the last trading day of the month as their signal, in 2019 Global Equities Momentum signaled them back into the stock market just in time for early March’s week-long downward slide. It seemed as if the signals were all wrong.
It is times like these which try investor’s patience. They might be tempted to adjust the Global Equities Momentum strategy.
Global Equities Momentum: A Profitable Strategy
The Global Equities Momentum strategy is a trend-following strategy based on Dual Momentum. It is supported by extensive academic research and back-testing. It’s long-term returns have been notable.
For example, the following table is a breakdown of Global Equities Momentum (GEM) results compared with a typical global asset allocation (GAA) portfolio*:
Table 2 – Global Equities momentum (GEM) Compared with Global Asset Allocation Portfolio (GAA)
|Jan 1950 – Sep 2018||Jan 1950 – Dec 1979||Jan 1980 – Sep 2018|
|Compound Annual Growth Rate||15.8||10.0||13.9||9.6||17.3||10.3|
|Annual Std Dev||11.5||9.8||10.2||8.3||12.4||10.9|
|Worst 6 Months||-15.7||-33.0||-15.7||-21.0||-15.0||-33.0|
|Worst 12 Months||-17.8||-35.7||-13.3||-28.1||-17.8||-35.7|
|% of Profit Months||69||67||67||68||72||63|
The overall long-term results are outstanding: greater returns with shallower drawdowns.
Then What Went Wrong?
Then what went wrong in the last quarter of 2018?
To look just at the performance of the last quarter of 2018 is taking a short-term view. Global Equities Momentum is an intermediate term strategy, designed to capture intermediate to long swings in the market. If an investor can capture these longer swings in the market, that investor will capture significant gains.
There are several things investors need to keep in mind when using Global Equities Momentum:
- Global Equities Momentum is not a short-term strategy.
- Avoid over-reacting to short-term performance. The stock market can be volatile, and some losing trades are to be expected.
- If you change or abandon Global Equities Momentum whenever it has losing trades, you are less likely to succeed.
- You cannot expect poor performance to be immediately followed by good performance.
- Neither can you expect poor performance to immediately follow poor performance.
- Volatility is normal. Therefore, you can expect some false signals and whipsaws from Global Equities Momentum.
- Trend following models like Global Equities Momentum will never sell at the top nor buy at the bottom.
- Investors don’t have to sell at the top or buy at the bottom to do well.
- Global Equities Momentum will handily outperform buy-and-hold, value investing, asset allocation, or moving averages.
Trends Are Established Over Time
However, it seems that a lot can happen between one month when a Global Equities Momentum signal adjusts a position and the next month when a new signal is given. Why not check for signals more often than once a month?
Stocks prices are more likely to rebound from short-term fluctuations than to continue in the same direction. Stocks are reactive over shorter periods of time such as days and weeks and take longer periods of time to establish trends.
Therefore, 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.
The Tax Impact
Additionally, there is another reason to avoid over-trading on short-term signals that occur with daily fluctuations. Global Equities Momentum uses a twelve-month lookback period on a monthly basis. There are twelve potential trades each year. Global Equities Momentum trades on average 1.3 times per year. 70% of Global Equities Momentum’s gains are long-term, while almost 100% of its losses are short-term. From a tax standpoint, it is better to have long-term capital gains, which generally are taxed at a lower rate, and short-term losses to off-set ordinary income at higher rates.
If you check for signals more often, say daily, the number of potential trades increase to 253 times per year. There will be twenty-one times more opportunities for trading. This will lead to more short-term trading, and the tax advantages of long-term capital gains will be lost.
Therefore, if you check for signals more often than on a monthly basis, the ensuing trading activity will lead to more choppiness in your holdings and the disappearance of tax advantages.
Every worthwhile investing strategy will have periodic drawdowns. When the drawdowns come, it is important to stick to the strategy. The strategy won’t be successful if we don’t stick to the plan.
*Global Asset Allocation Portfolio consists of 45% U.S. stocks, 28% non-U.S. stocks, and 27% 5-year bonds.
The returns indicated in the tables above are based on indexes. You cannot invest directly in indexes. Therefore, the products that you can invest in that track indexes will have administration expenses, transaction costs, and tracking errors to the actual index. What this means is that an investor will probably gain somewhat less than is illustrated here.
The foregoing article expresses my opinions only and does not constitute financial advice. You can take my opinions for what they are worth – my opinions. Even though I work for Wells Fargo, I am not a trained financial professional and the foregoing does not constitute financial advice. If you have any doubts as to the merits of a potential investment, you should seek the advice of a competent advisor.
Photo by Claudia Dermutz under CC BY-SA 2.0 license.