Sector versus Country Momentum

Does Performance Chasing Work?

June 2018. Reading Time: 10 Minutes. Author: Nicolas Rabener.

SUMMARY

  • The Momentum strategy can be applied to stocks, sectors and countries
  • Sector and country Momentum portfolios generate positive excess returns
  • However, cross sector & country and single stock Momentum portfolios generate higher risk-return ratios

INTRODUCTION

When a graduate joins the M&A division of an investment bank in Europe he or she often has to decide between a country or sector focus. Both have advantages and disadvantages, but are difficult to evaluate at the start of a career as an investment banker. Joining the Technology team was highly desirable in 1999, but much less attractive in 2002. Focusing on M&A transactions in Russia tends to be more interesting when oil and gas prices are high, but energy prices are volatile and difficult to predict.

Investors analysing European stocks often face a similar choice: should they focus on all of Europe, on certain countries or sectors? Many investors decide to simply chase performance and allocate to whatever country or sector has recently performed best, which is often criticised as an investment philosophy. Naturally this strategy can be evaluated quantitatively as it represents the Momentum factor. In this short research note we compare Momentum in sectors versus countries in the European stock market (read Momentum Factor: Intra vs Cross-Sector).

METHODOLOGY

We focus on the Momentum factor across sectors and countries in Europe, which comprises 11 sectors and 17 countries that are available as market capitalisation-weighted indices. The Momentum factor is created via a long-short beta-neutral portfolio based on the top and bottom 3 sectors or countries ranked by the returns over the last 12 months excluding the last month. Only stocks with a minimum market capitalisation of $1 billion are included. Portfolios are rebalanced monthly and each transaction incurs costs of 10 basis points.

SECTORS VERSUS COUNTRIES

Analysing the performance of various European stock markets from 2000 to 2018 reveals quite divergent returns. The compounded annual returns highlighted in the chart below display an almost perfect geographical split: northern countries like Nor