There’s a one-in-seven chance that stock market momentum will fail over any given 10-year period. That’s important to bear in mind since momentum is coming off one of those 10-year periods. Its failure has led to no end of soul-searching among advisers and researchers alike, wondering whether the venerable momentum effect may have stopped working permanently.

Their fretting was likely little more than wasted energy. Even if momentum is just as effective a strategy in the future as the past, the volatility of its returns is such that there is a not-insignificant chance that it will still lose money over any given 10-year period.

That is the conclusion I reached upon analyzing momentum’s performance since 1927 in the U.S. stock market, courtesy of the database maintained by University of Chicago finance professor (and Nobel laureate) Eugene Fama and Dartmouth finance professor Ken French. To measure the likelihood of momentum losing money over a given decade, I conducted 100,000 simulations in each of which I picked 120 months at random from the more than 1,100 actual months between 1927 and 2018.

These simulations produced a 10-year loss 13.1% of the time. To be sure, this finding doesn’t rule out the possibility that the momentum effect has become less pronounced in recent years, or even that it may have disappeared altogether. But the simplest and most straightforward assumption we should make when some long-standing pattern stops working is that it’s caused by nothing more than random fluctuations of the data — bad luck, in other words.

In reaching this conclusion, I closely followed the research design laid out by Fama and French in an article they wrote for the third-quarter of 2018’s issue of the Financial Analysts Journal. In this article, they reported on similar simulations for the small-cap effect (small-cap stocks outperforming large-caps) and the value effect (value beats growth). The frequency of negative 10-year returns that they found was similar to what I found for momentum.

The takeaway here is that it’s difficult for any of us to accept that we may lose money over a decade for no other reason than mere bad luck. Our psyches demand an explanation, since it requires too much cognitive dissonance to accept that so much pain could be caused by randomness. So we are led inexorably to come up with after-the-fact explanations for what happened.

We need to resist that impulse. The first possibility we should always entertain is that failure was caused by bad luck. Only when that possibility is ruled out should we begin to explore other possible explanations.

Consider the track record of a momentum-based advisory service that I monitor, NoLoad Fund X, whose editor is Janet Brown. The service constructs several different model portfolios of mutual funds based on their momentum, and over the long term these portfolios have performed well on average. But over the last decade they have lagged the market. (See accompanying chart.)

Since mid-1980, according to the Hulbert Financial Digest, the service’s average model portfolio has beaten the Wilshire 5000 index by an annualized margin of 11.8% to 11.0%. Over the past decade, in contrast, the service’s average model portfolio has lagged by a margin of 9.9% to 13.0%. (To put these results another way, the newsletter over the 28 years prior to the last decade beat a buy-and-hold by 2.1 annualized percentage points.)

Lagging the market by an annualized 3.1 percentage points over a decade is well within the range of what emerged from my simulations. So the simplest and most straightforward explanation is that the newsletter is coming off a rare, but not unprecedented, period of bad luck.

Accordingly, after such a poor stretch, NoLoad Fund X can be expected to soon start outperforming the broad market. This may have already begun, in fact. In 2018, according to the Hulbert Financial Digest, the newsletter beat the Wilshire 5000 index by 1.9 percentage points.

For more information, including descriptions of the Hulbert Sentiment Indices, go to The Hulbert Financial Digest or email .

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