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Momentum is defined as the tendency for investments that have performed relatively well in the recent past to continue to do so and for relatively poorly performing investments to continue to fare poorly. It is a well-documented anomaly in modern finance. Numerous academic studies have confirmed that, when measured in periods of approximately three to 12 months, past investment winners tend to keep on outperforming while past losers tend to keep underperforming.
Stocks that evidence positive momentum have returned a significant premium to the overall market. The following graph illustrates this premium in the growth of $1.00 invested in a portfolio of positive momentum stocks1 (in dark red) compared to the S&P 500 (in light brown) from August 1927 through July 2011.
The $1.00 investment in momentum stocks grew to $67,309, nearly 30-times larger than the $2,321 earned in the S&P 500. For long-term investors, this outperformance has been remarkably enduring. In 99.6% of the 10-year rolling periods since July 1937, momentum stocks have outperformed the S&P 500. The following graph illustrates this outperformance by comparing the rolling 120-month annualized performance of momentum stocks to the S&P 500 since July 1937.
1. The US Momentum stock portfolios were constructed by averaging the monthly returns of momentum portfolios 8 -10 selected from the 10 portfolios formed on momentum available from Professor Ken French’s website at http://mba.tuck.dartmouth.edu/pages/faculty/ken.french/data_library.html.
