Momentum is the premier market anomaly. It is nearly universal in its applicability.Gary then outlines how an investor can easily apply momentum through the use of asset pair modules to "effectively harvest risk premium profits". I highly recommend anyone interested in momentum or learning more about momentum to check out the (easy to understand) white paper that you can download here.
Reading the paper gave me an idea for a test that I felt would further show how universal momentum truly is. The test? How well would an investor have done applying momentum to the various cities that make up the Case Shiller Home Price Index, pretending (of course) that each city index was investable and liquid (i.e. things they aren't).
First, a quick update on the Case Shiller Home Price Index. To the Huffington Post:
The Standard & Poor's/Case-Shiller home-price index shows that prices dropped in February from January in 16 of the 20 cities it tracks.Yikes... let's see what momentum can do with this mess.
The steady price declines have brought the nationwide index to its late 2002 level. Home prices have fallen 35 percent since the housing bust.
Prices in nine cities fell to their lowest levels since the housing bust. The average price in Atlanta fell 17.3 percent in February compared with a year earlier. That's the biggest annual drop in the history of the index for any city.
1) Take the 6-month rolling return for each city
2) Allocate the next month to the city that had the highest six month return
How well would we have done?
The chart below outlines the performance of this relative strength allocation, the composite-10, and Portland (which happened to be the best performing city over this time frame... who knew).
For those keeping track at home, that's a 12.7% annualized return for the relative strength index vs. 3.3% for the composite-10 and 4.8% for Portland, despite there being no rule that allowed an investor to get out of the market.
Not too bad.
Source: Case Shiller
One reason I was drawn to Gary's paper is that it is remarkably similar to something I've been working on for the better part of the past year, which itself is based on conversations that I've had with Meb Faber from World Beta over the past few years. If you haven't read Meb's paper A Quantitative Approach to Tactical Asset Allocation, another strong recommendation.