Mindful about momentum
Author: Stephen Duench
August 13, 2019
Why today’s winning stocks may end up being tomorrow’s losers
The S&P/TSX Composite Index, Canada’s top equity benchmark, has cooled off after a great start to the year, but one factor that has remained red hot in recent weeks is momentum.
Based on AGFiQ data, stocks that did the best over the past three months (the winners) outperformed stocks that did the worst (the losers) by an average return of at least 40%. This is true regardless of whether the analysis was done using a trailing one, three, six or 12-month time horizon, suggesting short-term moves in momentum accelerated over this stretch and bled into longer-term moves, a rare occurrence.
Source: AGFiQ with data from FactSet as of August 2, 2019. Quintile spread of the three-month performance between stocks with the best and worst momentum in the S&P/TSX Composite Index over the trailing one, three, six, and 12-month time horizons.
In fact, such a synchronized outperformance in momentum has happened less than 4% of the time since 2001 and has equated to a standard deviation of 3.5 times above the average performance spread between winners and losers.
Again, this is extreme and when happening in the past, it has often been followed by a period of mean reversion that can flip the market on its head.
But that doesn’t tell the whole story. From a valuation standpoint, there have only been two periods in the past twenty years in which stocks with the best medium to long-term momentum have been this overvalued compared to those with the worst momentum.
Source: AGFiQ with data from FactSet as of August 2, 2019. Quintile spread of the trailing earnings to price ratio between stocks with the best and worst momentum in the S&P/TSX Composite Index over the trailing six and 12-month time horizons.
Given all of this, the momentum trade has become increasingly risky and investors should consider a cautious approach when evaluating current winners, while also taking a second look at the underperforming segments of the market.
Gold stocks, for instance, have been one of the biggest gainers so far this year, but are overrepresented in our first quintile ranking of stocks based on momentum.
Conversely, energy stocks—especially small cap companies engaged in oil and gas exploration and production—and forestry stocks are overrepresented in the weakest quintile and have also hit significant negative standard deviations versus their own history over varying periods this past year.
Stephen Duench is a vice president and portfolio manager with Highstreet Asset Management Inc. Abishek Ashok is an analyst with Highstreet Asset Management Inc. Both are members of the AGFiQ quantitative investment team.
AGFiQ is a collaboration of investment professionals from Highstreet Asset Management Inc. (a Canadian registered portfolio manager) and AGF Investments LLC (formerly FFCM, LLC). This collaboration makes-up the quantitative investment team.
The commentaries contained herein are provided as a general source of information based on information available as of August 2, 2019 and should not be considered as investment advice or an offer or solicitations to buy and/or sell securities. Every effort has been made to ensure accuracy in these commentaries at the time of publication however, accuracy cannot be guaranteed. Investors are expected to obtain professional investment advice.
The views expressed in this blog are those of the author and do not necessarily represent the opinions of AGF, its subsidiaries or any of its affiliated companies, funds or investment strategies.
AGF Management Limited (“AGF”), a Canadian reporting issuer, is an independent firm composed of wholly owned globally diverse asset management firms. AGF’s investment management subsidiaries include AGF Investments Inc. (“AGFI”), AGF Investments America Inc. (“AGFA”), Highstreet Asset Management Inc. (“Highstreet”), AGF Investments LLC (formerly FFCM LLC) (“AGFUS”), AGF International Advisors Company Limited (“AGFIA”), AGF Asset Management (Asia) Limited (“AGF AM Asia”), Doherty & Associates Ltd. (“Doherty”) and Cypress Capital Management Ltd. (“CCM”). AGFI, Highstreet, Doherty and Cypress are registered as portfolio managers across various Canadian securities commissions, in addition to other Canadian registrations. AGFA and AGFUS are U.S. registered investment advisers. AGFIA is regulated by the Central Bank of Ireland and registered with the Australian Securities & Investments Commission. AGF AM Asia is registered as a portfolio manager in Singapore. AGF investment management subsidiaries manage a variety of mandates composed of equity, fixed income and balanced assets.
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Written by
Stephen Duench, CFA®
Vice-President and Portfolio Manager
AGF Investments Inc.
Abhishek Ashok, M.A., MFE, CFA®
Analyst
AGF Investments Inc.
