The Momentum Anomaly
Earnings Growth as the Fundamental Driver of the Momentum Anomaly
The connection between past stock market returns and subsequent performance is among the more analyzed stock market anomalies. In numerous studies, the trend in stock prices has been found to have a significant correlation with future stock prices, albeit with differing signs over differing time horizons. Rosenberg Equities research has focused on the connection between medium-term price momentum1 and measures of trailing and expected earnings. We suggest a theoretical linkage and find empirical evidence for a connection between trailing relative performance and the evolution of company earnings. In short, we show that medium-term trailing price performance is a robust predictor of forward earnings growth at the individual company level. Importantly, we believe that momentum’s positive and very stable correlation with year-ahead change in earnings yield aligns it with the fundamental driver of equity returns. It is this relationship that is at the core of the momentum anomaly.
The “momentum anomaly” typically refers to patterns in which the best performing stocks over the prior 3 to 12 months continue to outperform weaker performing stocks over the next 12 months2 . We, and many others, have observed a return premium to the momentum anomaly.
- Medium-term momentum can be thought of as positive relative strength over a year-long period. It is distinct from short term momentum trends that can be daily or even intra-day in duration.
- Note that “price momentum” and “relative strength” are often used interchangeably. Both terms capture the concept of a stock (or group of stocks) being “on a roll” compared to peers.