Earnings Momentum Strategies Dominate in Europe…
With >50% of European stocks seeing positive earnings revisions YTD, we review the efficacy of investing in consensus earnings momentum (EM) strategies relative to price momentum (PM) strategies. We adapt a method
employed by Chordia and Shivakumar (2006) to show that in Europe over the past decade, the excess returns generated by PM strategies are subsumed by earnings momentum. The reverse is not true. Effectively
therefore, “an investor who wants to trade momentum would lose nothing by completely ignoring price momentum” (Novy-Marx, 2015).
…But Be Aware of Embedded Sector Tilts
There are clear sector biases in an unconstrained earnings revisions strategy. At its most extreme, we observe that up to 60% of the long leg of the 1m FY2 earnings revisions strategy has been comprised of just three sectors. We find that both GS’ Eurozone Current Activity Indicator & the performance of GS Commodity index are strong lead indicators for sector skews in our preferred EM strategy (based on 1m FY2 consensus revisions).
Boosting Price Momentum Performance using Earnings Revisions
Over the past decade, buying stocks that combine strong 12m-1m price momentum (our preferred PM strategy) and strong 1m FY2 consensus earnings revisions has delivered higher annualized returns than a 12m-1m PM strategy. We find that the information ratio of the PM strategy is also boosted by adding a 1m FY2 revisions overlay, albeit with higher turnover.