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The Hidden Cost of Volatility Drag

The markets have always been driven by sentiment, with investors reacting to news, events, and even seemingly minor changes in the economy. But what if we told you that one pattern dominates the market: timeseries momentum? That's right; it's time to rethink our approach to asset pricing.

That said, we're not here to make a bold new theory of asset markets. Instead, we'll dive into the existing literature and explore some intriguing findings about timeseries momentum in various asset classes.

The Momentum Literature

The momentum literature focuses on relative performance over short periods (three to 12 months). It often finds that historically outperforming stocks continue to outperform their peers. This is reminiscent of sentiment theories, which suggest that investors are influenced by market news and trends.

But here's where things get interesting: we've found persistence in returns for one to 12 months across a wide range of asset classes, including equities, currencies, commodities, and bonds. We're talking about strong positive predictability from past returns – almost as if the markets have developed some kind of "trend" effect.

Timeseries Momentum Across Asset Classes

We looked at specific futures contracts for country equity indexes, currencies, commodities, and sovereign bonds over 25 years of data. And what did we find? Time series momentum is remarkably consistent across different asset classes. In fact, it's almost as if these markets have developed a kind of "trend" effect.

That said, the correlations between time series momentum strategies across asset classes are larger than those within each class itself. This suggests that there's a stronger common component to timeseries momentum across different assets.

Portfolio Implications

So what does this mean for portfolios? It means diversifying your portfolio into a range of strategies with varying levels of time series momentum. We're not suggesting that you go out and start buying or selling every strategy – just that having a mix can help capture the benefits of timeseries momentum.

We've found that 12-month time series momentum profits are positive, not just on average across these assets, but for every asset contract we examined (58 in total). That's substantial returns with relatively little exposure to standard asset pricing factors.

A Different Perspective

That's where things get interesting. What if your sentiment analysis is missing the mark? Are you ignoring some crucial factor that could be driving your returns? Or perhaps you're overemphasizing the importance of short-term momentum at the expense of long-term considerations?

Whatever the case, timeseries momentum offers a unique perspective on asset markets. By focusing on past returns rather than just current trends, we can gain insights into the underlying dynamics driving the market.

Three Scenarios to Consider

So what scenarios might you consider when applying time series momentum? One is to use it as a risk management tool – to identify potential pitfalls and opportunities in your portfolio. Another is to leverage it as an investment strategy – to try out different approaches and see which ones work best for your investors.

Finally, there's the possibility that timeseries momentum could be used to predict market downturns. Imagine being able to catch emerging trends before they become popular – or using them to bet against a particular market sector.

The data actually shows us that time series momentum is not just about making predictions; it's also about capturing opportunities and avoiding losses. And with the right strategy, you could be well on your way to achieving substantial returns in volatile markets.

The Verdict

In conclusion, timeseries momentum offers an intriguing new perspective on asset markets. By focusing on past returns rather than current trends, we can gain insights into the underlying dynamics driving the market. Whether you're looking to diversify your portfolio or use time series momentum as a risk management tool, this phenomenon is definitely worth exploring.