London markets have enjoyed a rocky but undeniable mini bull run since early June, with the FTSE 100 now a good 600 points ahead of where it was five months ago. While many investors are understandably wary of reading too much into short term market movements like these, it's still worth tracking which companies and sectors have been benefitting from the advance.
Tracking individual companies that are displaying strong relative price strength in the market and perhaps even trading at (or close to) their 52 week highs has been shown to be a useful buy or sell indicator. The momentum concept was originally observed in a 1993 paper by Jegadeesh and Titman, and you can read more about the phenomenon here. In recent weeks we have looked at various shares that are enjoying strong price strength, including housebuilders, oil companies and bargain Piotroski stocks and why they could still have further to run.
Sector momentum rocks
While it's worth monitoring which stocks that are racing ahead of the pack, a powerful twist on the concept of momentum (and arguably an even more successful trading strategy) is to look at which sectors are leading the momentum charge. This was the focus of an influential 1999 study by Moskowitz and Grinblatt, which found that industry momentum investment strategies, which buy stocks from past winning industries and sell stocks from past losing industries, can be highly profitable. Moreover, they found that industry momentum almost always subsumes individual stock momentum – meaning that once you control for industry momentum, regular stock momentum is much less important.
It was a similar story in a 2011 study by Hong, Jordan and Liu, which found that a trading strategy using the 52-week high effect (where stocks at or near their 1-year price highs often go on to trade higher) was considerably enhanced by focusing on sectors rather than individual stocks.
So how can investors use these findings in practice? At Stockopedia we track the 52 week high screen and among the most interesting patterns that emerges from the 50-strong universe of companies are the hot sectors on the move. Not only does this screen give you a feel for the industries that are in favour among investors but the stock breakdown reveals the types of companies that are leading the pack in each one. Right now, consumer cyclicals, financials and industrials make up the lion’s share of qualifying stocks.
1. Consumer cyclicals
Despite their vulnerability to economic conditions and consumer confidence, consumer cyclicals such as pub groups and retailers have performed robustly this year. Commentators on both sides of the Atlantic have pointed to decent growth rates and reasonably strong dividend yields as reasons why investors have remained keen on these types of stocks.
Among the big retailers, Mothercare (LON:MTC), Marks and Spencer (LON:MKS) and Next (LON:NXT) all currently qualify for the 52-week high screen. Mothercare is the best performer, helped in no small part by an upbeat trading update in October, which signalled that efforts to breathe life into sales could be paying off. At the smaller end, PR group Next Fifteen Communications (LON:NFC) had been among the steepest risers but that performance was slashed on news of a “complex fraud” in its Bite North America business. Elsewhere, newspaper distributor Smiths (LON:SMIN) and restaurant operator Restaurant (LON:RTN) also make the list.
Banks were blitzed in the 2008/09 economic meltdown and most have yet to make up the lost ground. Despite reputations and share prices lying in tatters, financial stocks have nevertheless been on the move of late. Big banks are largely absent from the 52 week high screen, with better performances recorded by some of the smaller players. Arbuthnot Banking (LON:ARBB) has been on a strong run since the turn of the year, when it opened at 338p. It currently trades at 646p as investor have continued to warm to an ongoing overhaul of its operations, including a stronger emphasis on its retail banking business. Consumer credit and motor finance business S and U (LON:SUS) appears on the list, as do investment banking firms Numis (LON:NUM) and Brewin Dolphin Holdings (LON:BRW).
Economic uncertainty has had a mixed impact on London listed industrials groups. Weak activity and uncertainty surrounding the Euro Zone haven’t helped, but the companies on the 52 week high screen are obviously doing well despite this. The largest of the industrials to make it on to the 52 week high screen is precision engineering company Renishaw (LON:RSW), which has seen its shares jump by 327p to 1770p in five months. Elsewhere, a handful of other FTSE 250 stocks also appear, including Speedy Hire (LON:SDY) and De La Rue (LON:DLAR), plus the notable AIM-quoted performer Judges Scientific (LON:JDG). In the case of scientific instrument maker Judges, the shares have actually been on a steady upward trend since mid-2009. A couple of acquisitions and another year of record results have provided extra impetus, driving the shares from 656p to 862p since May.
What does it all mean?
So how do these findings tally with wider thinking in the market? Matt Hudson, whose Cazenove UK Equity Income fund is among the top performing institutional growth funds so far in 2012 is heavily focused on consumer cyclicals, financials and industrials. In his latest note to investors, Hudson said financials and consumer cyclicals remained the core focus for his new investments and while industrials looked vulnerable in the short term, the UK market overall still offers “a range of attractively valued opportunities and with well covered yields and with real growth”.
Given the volatility in the market, anyone watching the 52 week high screen will see quite a lot of movement of stocks in and out on a daily basis. Amidst that flurry of names, it's well worth keeping a close eye on the sectors which crop up again and again – most recently, that's been consumer cyclicals, financials and industrials. How is your portfolio positioned with respect to those sectors? The research suggests that playing the momentum effect is as much about sector weighting as anything else.
Filed Under: Momentum Investing,