Back on Monday, the CXO Advisory Group noted some fascinating results from a U.K. study of the long-term performance of short-term "winning" and "losing" stocks.
As presented by CXO, here are three key implications of the research conducted by Glen Arnold and Rose Baker:
- Stocks that are the biggest losers over the past five years (39 five-year ranking periods) generally outperform both the past winners and the overall market over the next five years. Specifically, equally-weighted portfolios of the 10% biggest losers (winners) over the past five years outperform (underperform) the equally-weighted market by an average of 53% (47%) over the next five years.
- The more extreme the return during the past five years, the greater the reversal the next five years. (See the chart below.)
- Extreme past losers outperform extreme past winners by an average of about 14% per year over the next five years. Past loser (winner) portfolios underperform the market approximately one quarter (three quarters) of the time.
Remarkable, no? Beyond the obvious point of long-term reversals per se (i.e., a powerful form of mean reversion), the broader implication here is that market participants tend to push securities too far in both directions...but only for so long.
If there is any systematic momentum effect in the stock market, it's only accessible on shorter time horizons, as CXO notes: "The time intervals used in this research are generally longer than those used in the study of momentum investing, with momentum an effect of months-to-a-year and reversal a multi-year phenomenon."
Glen Arnold and Rose Baker, "Return Reversal in U.K. Shares," SSRN, July, 2007