Monday, September 16, 2019

Momentum meltdown not a trend-following meltdown

Trend-following is not momentum investing. They are similar and have many of the same characteristics and have been often described as being the same, but investors should not be confused. There has been a momentum meltdown this month, but there has not been a trend-following meltdown. 

Trend-following looks at times series behavior for a wide range of markets and will buy (sell) those that are moving higher (lower) based on some absolute criteria. There is not the expectation that the long trends will be matched against short trends Momentum strategies often applied to equity markets are cross-sectional. Market momentum is measured and ranked with the portfolio going long the highest momentum stocks and short the lowest momentum. The portfolio will be a long/short match based on these relative ranking.   

There has been a positive change in the macro environment which has hurt the strong bond trends seen since spring. This increase in bond yields has shocked many trend-followers who have been long the global bonds, but this move is independent of the momentum crash in equities which have seen a rotation from momentum growth to value stocks. There may be similar causes but the factor styles are different. 

Trend-followers generally focus on futures markets and not individual equities, hence the reference to managed futures. There can be further revisions from  changes in macro markets but this is not the same as a style factor rotation in equities.

Using CSAIX as a managed futures trend-following proxy and MOM as momentum proxy, we can see that they are related but the trend-following is more closely related to bond positioning and behavior. The trend-following program is less likely to have crash effects given its diversification. During this same time, there has been a positive shock to the value style. Herding behavior is often captured in the momentum strategy and will be subject to crashes when there is a major change in expectations. Trend-following may also be subject to trend revisions but the drivers will be associated with broader market changes.

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