Trying to understand how the economy works for investing in equity markets is a difficult task that can lead to failure. Smart investors take the beta with minimal effort. Here is an example.
Everyday, there are thousands of posts on financial media by people who attempt to understand how the economy works for the purpose of investing. They usually focus on a few variables and try to make predictions. However, the state of the economy is unpredictable due to its highly non-linear stochastic nature. Randomness fools some analysts who think they can predict the state of the economy and the market’s response, while other analysts use fancy terminology in an effort to impress the audience.
Consider the good, effortless beta. An analysis of the economy is not required for simple investing but only for more advanced asset allocation strategies. There are many versions of this beta, but the simplest arises from the momentum anomaly. A basic strategy relies on the 12-month moving average: stay invested in as long as the price is above the 12-month moving average, and sell when it falls below it. The following is a backtest of the application of this simple strategy to SPY ETF from inception to September 4, 2024.
The annualized return of this simple strategy is close to 9.4%, compared to 10.3% for the buy and hold strategy, but the drawdown is less than half, at 22.6% versus 56%.
How many macro or technical analysts have outperformed this simple strategy? My guess is very few, despite their constant effort to predict the future.
There are more advanced strategies that take advantage of the momentum anomaly and its various manifestations for traders and investors, but the simple 12-month momentum strategy is a useful starting point.
All strategies can fail when the underlying anomaly vanishes. However, momentum has persisted for hundreds of years, and it is unlikely that it will go away as long as the economy generates wealth.
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Specific disclaimer: This report includes charts that may reference price levels. If market conditions change the price levels or any analysis based on them, we may not update the charts. All charts in this report are for informational purposes only. See the disclaimer for more information.
Disclaimer: No part of the analysis in this blog constitutes a trade recommendation or actionable content. The past performance of any trading system or methodology is not necessarily indicative of future results. Read the full disclaimer here.
Charting and backtesting program: Amibroker. Data provider: Norgate Data
