Momentum is one of the most powerful tools investors and traders can apply to their portfolios. I am using relative momentum to allocate between different types of bonds and to over-weight U.S. or Foreign stocks within the IRA strategies I manage. At the end of March, I pulled up the following chart from stockcharts.com and was astonished to find out that Foreign stocks (ACWX) had a better one year performance than U.S. Stocks (SPY). My Dual Momentum Model hasn’t switched to Foreign Stocks since I have been using it and it has been riding the rocket ship that was U.S. stocks for over a decade. Has an important regime change begun?
Here is a refresher on how I use Dual Momentum. At the end of each month, I pull up a chart above to determine whether foreign stocks or U.S. stocks have had stronger performance for the trailing one year period. Whichever has the momentum gets an 80% allocation for the entire month, no matter what happens during the middle of the month. I like that this model doesn’t try to time in and out of stocks, has very few trades, and it just follows price. There are periods of volatility where it will flip back and forth and get whipsawed. Where the magic happens, is when a strong long-term trend develops and you get to ride the relative strength of U.S. or Foreign stocks.
Dual Momentum flipped at the end of March and I have had 80% of clients’ stock allocation in Foreign stocks for all of April, May, and now we will stay over-weight Foreign stocks for all of June. This model could flip back to over-weight U.S. stocks at any time, but I am hopeful that this is the big trade I have been waiting for. Below you can see since 2010, U.S. Stocks (red) have gone up 375% while Developed Foreign stocks (blue) and Emerging Markets (green) have only gone up a paltry 95% and 45% in 13 long years. With hindsight, being over-weight U.S. stocks was one of the smartest decisions you could have made after the Great Financial Crisis. At some point, cheaper Foreign stocks will take the lead. I am hopeful this has begun now.
After over a decade of demolishing the returns of Foreign stocks, U.S. stocks are trading at much higher valuations (some would say rightfully so). Below on the left are different valuation metrics from Morningstar.com for SPY and on the right we have the metrics for ACWX. You can see that the valuation metrics for SPY (left) are all higher than those for ACWX (right). This makes sense because the price of U.S. stocks have done much better than the price of Foreign stocks.
If this is the beginning of a long-term regime change, I don’t think it would be because of valuations and a weak dollar alone. I think you would also see investors rotating out of the Mega-cap tech stocks that dominate the U.S. stock market and into more “real economy” sectors like materials, industrials, banking, and energy. Below are the different sector weightings from SPY on the left and ACWX on the right that I gathered from Morningstar. The foreign index has 3.5 times the Basic Materials of the U.S. and less than half the tech exposure. You can see owning the Foreign stock market has a very different composition of the type of stocks you hold.
Could we be in for a lost decade for U.S. stocks like the 1970s and the 2000s? Absolutely. On most metrics the U.S. stock market is still not cheap and anything can happen. Below is a chart of the Japanese stock market from 1980 until now from Yahoo Finance. The narrative back then was the Japanese work harder and are better at STEM than the rest of the world and will rightfully end up owning the entire world. Sony, Toyota, Honda, and Mitsubishi are all awesome and Zenith, Ford, Chevy, and Honeywell suck. At the end of 1989, the Nikkei 225 was at 39,000 and 33 years later it stands at 30,500! How many years did it take for Japanese investors to realize they aren’t going to hit their retirement goals by owning mostly Japanese stocks? My momentum model will help us avoid this if the U.S. stock market faces a similar decline.
At the turn of the Millennium, the UK FTSE 100 hit 6,950 and as recently as September of 2022, the index was at 6,950. That is 22 years of a 0.0% annualized return. After an enormous consolidation of two decades, the UK market is just 3% below its recent all time high while the S&P 500 is about 15% below its. Bonds can trade with negative yields, oil can go negative, and entire stock markets can perform worse than bonds for decades.
Investors are painfully aware that U.S. stocks did poorly in 2022 while inflation averaged 8%. You probably aren’t aware that inflation was 95% in Argentina and Turkey’s was over 80%. The blue line below is the Turkey ETF (TUR) and the red line is the Argentinian ETF (ARGT). With scorching hot inflation they did 107% and 12% respectively in DOLLAR TERMS in 2022 while U.S. investors were losing money.
I run my 12 month comparison using Avantis funds and it was really close this morning. The model will remain 80% in Foreign stocks and 20% in U.S. stocks for the month of July. It is impossible to know if this is going to be the 5-10 year FLIP that makes this momentum model a hero or if this was a three month blip and the U.S. market has some more outperformance ahead of it. I am concerned how the U.S. stock market is becoming more and more concentrated in Mega Cap Tech. History has shown that once you get that big, your stock stops outperforming the overall market. Perhaps this time is different.