Dual Momentum is one of my favorite investment strategies for do-it-yourself investors. The historical performance of Dual Momentum—even in the now effete twelve month lookback form—has been fantastic going back nearly seven decades.
There is no other strategy I can think of where investors can experience double digit annualized gains over full market cycles with 25 percent drawdowns (in the worst case) and just a couple trades per year.
Although the long backtests are beautiful and the results are solid, Dual Momentum has come under a lot of fire lately. Investors who employed the strategy are losing faith after several shakeouts in the past couple years, the quants are poking holes in the mechanics of the strategy, and the buy-and-holders are flaunting massive gains as the market keeps jumping up on every dip.
An argument that's been made before, and I've been on that side as well, is that we can expect equity trend strategies to underperform the index in the upside portion of market cycles. This is often observed in single market backtests. As a trend strategy, Dual Momentum would fit this argument.
However, Dual Momentum doesn't just beat the benchmark by a few points annualized as we see with single market trend models by avoiding long downtrends. Dual Momentum has crushed the market by also picking the strongest equity class—U.S. or International—in the broader market upwards half-cycle.
I want to focus on the "bull market" or upside half-cycles in U.S. equity markets because this is where trend investing can tend to underperform equity portfolios. To help put this relative performance into a visual format, I decided to look at all the "bull market" phases since 1970. We'll see how a Dual Momentum investor would have felt standing beside the S&P 500 and a balanced portfolio (33.3 percent U.S. stocks, 33.3 percent International stocks, and 33.3 percent bonds).
We know Dual Momentum has avoided the deep drawdowns of extended market downwards half-cycles. In other words, I believe it is unlikely to see a Dual Momentum investor complaining about their recent performance at a time like the summer of 1974, summer 2002, or fall 2008.
July 1970 to December 1972
In this short bull market Dual Momentum underperformed the benchmark portfolios for more than a year into the cycle. Dual Momentum quickly caught up in the latter half of this half-cycle, essentially meeting U.S. stock performance at the cycle peak.
October 1974 to November 1980
The dynamics of the late-70s upwards cycle was very similar to the brief earlier cycle. Stocks ran hard at first with Dual Momentum lagging behind for the first half of the cycle. However, later in the cycle Dual Momentum caught up again, barely edging out stocks over the entire half-cycle period.
August 1982 to August 1987
While the mid-1980s market half-cycle started off similar to the previous bull markets in the 1970s, it certainly finished different. Dual Momentum lagged at first, for approximately a year and a half, but the signal moved the Dual Momentum investor into International stocks. For the next few years International stocks wildly outperformed U.S. stocks and a Dual Momentum investor finished the half-cycle much wealthier than an American focused investor.
Even the normally lagging Balanced Portfolio performed neck-and-neck with U.S. stocks. While the bond component may have held returns back, the International stock allocation gave the Balanced Portfolio a lot of strength into the latter half of the upwards portion of the cycle.
We all know what happened to U.S. stocks in October 1987. What many people don't know is that International stocks did much better in that crash comparatively. By holding International stocks, Dual Momentum did better in that sudden crash, even with a full equity allocation.
November 1987 to August 2000
As the chart shows, this long market upwards cycle was almost all U.S. stocks driving the performance. Dual Momentum got a bit of an edge on U.S. stocks when the market shifted to bonds in 1990 and to International stocks in 1994.
Overall both Dual Momentum and U.S. stocks gave a 9x return in little more than a decade. The momentum was so strong that the Dual Momentum signal held in U.S. stocks for the 1998 Bond and Currency Crisis, riding to the peak of the U.S. telecom and tech bubble.
October 2002 to October 2007
This half-cycle we're back to the familiar performance of Dual Momentum lagging the market for the first half of the upwards cycle. Again, Dual Momentum finishes strong as International stocks took off in the mid-2000s. In fact, Dual Momentum had investors in International stocks for the vast majority of this half-cycle.
March 2009 to April 2019
This market half-cycle has been a significant deviation from the past cycles we've looked at. Normally, a couple years into the cycle, Dual Momentum would surpass the returns of the Balanced Portfolio and U.S. stocks. and pull away from there.
Although I don't have data going as far back as Dual Momentum's publisher, we have never seen Dual Momentum perform this poorly in a market half-cycle. Dual Momentum has never lagged the S&P 500 or a Balanced Portfolio by so much for so long.
For some perspective, U.S. stocks would have to fall 60 percent to match Dual Momentum's returns over this market half-cycle. It would take a 25 percent decline for the Balanced Portfolio. This number isn't impossible. In fact, very prominent market researchers have been suggesting a 60 percent decline in U.S. stocks would be necessary just to get us back to a baseline historical valuation.
For myself, I am not sure where markets are going to go. One thing I do know is that zooming into shorter period performance can help us get a picture of how a strategy performs.
If there are clues that something may be shifting in the performance of a strategy, we need to keep a more careful eye open. In my research I've seen long-term shifts in other investment strategies; once winning strategies becoming laggards. Of course they are only seen in hindsight, but it is important to look for these shifts before they drag down your portfolio returns for decades.
While I'm not abandoning Dual Momentum, I am somewhat less confident in the strategy than I used to be. It would take a pretty solid relative performance in the next downwards half-cycle to renew full confidence in the strategy. Gary Antonacci has previously mentioned that he would look to full market cycle performance to determine the effectiveness of Dual Momentum. I would say that a potential challenge is in the works.
For now, I am still comfortable staying with Dual Momentum for a good portion of my portfolio. However, as I've advocated for many times before, don't put all your money in a single strategy. Mix it up. Spreading your bets across a few strategies can reduce a multitude of risks much better than small adjustments within the strategy that try to adapt to market conditions or reduce some of the risks present the strategy.
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