How do value and momentum interact with each other and with size, economic and liquidity factors worldwide? In the November 2013 version of their paper entitled “Size, Value, and Momentum in Developed Country Equity Returns: Macroeconomic and Liquidity Exposures”, Nusret Cakici and Sinan Tan address this question for developed markets. They use long-short, factor-sorted portfolios to measure size, value and momentum premiums. They consider future Gross Domestic Product (GDP) growth and future consumption growth as economic factors. They consider both funding liquidity (a potential indicator of investor margin cost, focusing on the difference between interbank lending rate and short-term deposit yield) and stock market liquidity (the estimated cost of trading stocks). Using monthly stock returns, firm accounting data and economic data for 23 developed countries during January 1990 through March 2012, they find that:
- Small stocks do not significantly outperform large stocks based on gross returns in any country.
- Gross value and momentum effects are widespread and consistently survive adjustment for various measures of the market return.
- In nearly all countries, gross value and momentum effects are smaller for big stocks than small stocks. Lower trading frictions tend to compensate for the smaller premiums of big stocks.
- The gross value premium consistently relates negatively to the gross momentum premium in a given country. The correlations are more negative and significant for big stocks than small stocks, such that value-momentum diversification is more effective for big stocks. Moreover, most gross value premiums relate negatively to gross momentum premiums in other countries.
- Gross momentum premiums are more highly correlated across countries than gross value premiums, suggesting that global investors focus more on momentum than value.
- Gross value returns are typically lower prior to a recession, while gross momentum returns exhibit little sensitivity to economic growth.
- Gross value (momentum) returns are typically lower during (indifferent to) intervals of poor funding liquidity.
- Gross value and momentum returns are typically higher when stock market trading frictions are high. However, stock market liquidity measurements are for the U.S. market, so this finding is most relevant to the U.S.
In summary, evidence from developed markets indicates that gross value and momentum premiums: (1) are pervasive and stronger among small stocks; and, (2) generally relate negatively, more strongly for big stocks.
Cautions regarding findings include:
- The study examines gross, not net, returns. As indicated in the authors’ mentions of transaction costs, results for net factor premiums may differ considerably from those for gross factor premiums.
- While measuring factor returns via long-short portfolios, the study does not consider the cost/feasibility of shorting. It is possible that stocks driving short-side returns are costly to short, or not available for borrowing to short.
- Interactions of momentum and value premiums with economic growth involves look-ahead data and so are not exploitable without a means of predicting economic growth.
