Why Consider Momentum in a Post-Coronavirus World?
The impact of coronavirus-related shutdowns has been significant. Unemployment is soaring, GDP is shrinking, and corporate earnings are evaporating. In addition, there is much uncertainty as to what the future will look like in both a medical and economic sense.
From a financial perspective, much of the data that investors often rely upon to make decisions, such as corporate financial statements and analysts’ earnings estimates, may be unreliable. Yet, one metric, namely momentum, may be unaffected by dubious data.
Why may the pandemic have caused much of the commonly-used metrics to become suspect or irrelevant? Why may momentum be unaffected? How may the Armor US Equity Index ETF (ARMR) help investors navigate this uncertain time?
Garbage In, Garbage Out
Many investors utilize metrics such as valuation, quality, and growth. These are affected by the data that is used to calculate these metrics.
Valuation metrics often compare elements of a company’s price or market value to measures of earnings (P/E) or book value (P/B). Price-to-earnings are calculated using historical or estimated earnings. As companies post negative earnings, such metrics may become less reliable. Additionally, uncertainty over the future may render analysts’ earnings estimates suspect. P/B may become irrelevant as companies are forced to take large write-downs of asset values, wiping out large chunks of book value.
Quality measures are often calculated using items from a company’s balance sheet. Again, these may be severely impacted by write-downs or other events that may negatively impact the assets on a company’s balance sheets. For example, a large write-down of assets may affect a company’s return on assets (ROA) or return on equity (ROE). It may also affect many asset and liability based ratios such as debt-to-equity, accruals, etc.
Measures of earnings growth may be skewed as many previously healthy and fast-growing companies report losses during 2020. Additionally, earnings growth measures using 2020 as the starting point may be less useful if they are negative.
Strategies that rely on dividend yield or dividend growth may also become unreliable as companies may need to cut or eliminate dividends to preserve cash.
This is not an exhaustive list of metrics and strategies that may be affected by the extreme economic effects of the coronavirus-related shutdowns. But, it does highlight that traditional measures used to analyze stocks and construct portfolios may be impacted in the future.
Go With Mo
However, one factor that will not be directly affected by the impact of coronavirus-impacted financial statement data is momentum. Unlike other measures, momentum is calculated using only one piece of data – a stock’s price. And, for the most part, stock prices are directly observable via the stock market.
There are many explanations for why momentum may work. While the explanations are varied, momentum has been widely studied and has been shown to add value.
Perhaps, momentum can pick up on trends and expectations that are not readily observable in the data but reflect rational future expectations. Price can also be thought of as an amalgamation of the market’s wisdom and its assessment of the value of a company.
While many traditional investment factors and strategies may become irrelevant due to the impact of coronavirus on financial statements, momentum has the potential to remain effective.
How can investors gain exposure to momentum?
The Armor US Equity Index ETF (ARMR) Utilizes Sector Momentum
The Armor US Equity Index ETF (ARMR) seeks to provide investment returns that, before fees and expenses, correspond generally to the total return performance of the Armor US Equity Index. The index is designed to provide exposure to the sectors of the US equity market that the fund’s index provider believes are most likely to generate positive returns while providing downside protection and experiencing lower volatility relative to the US equity market.
The index which serves as the basis for ARMR uses sector momentum, which looks to invest in sectors that have been experiencing positive performance, in an aim to achieve its goal.
Investing in ARMR may provide investors with exposure to momentum in a vehicle that is designed to manage equity risk.
The outbreak of COVID-19 has negatively affected the worldwide economy, individual countries, individual companies and the market in general. The future impact of COVID-19 is currently unknown, and it may exacerbate other risks that apply to the Fund
Past performance does not guarantee future results. Short-term performance may often reflect conditions that are likely not sustainable, and thus such performance may not be repeated in the future.
 Petruno, Tom, After a Quarter Century of Sprawling Study, It’s Time to Narrow the Focus and Settle on An Explanation, 10/31/18