Abstract
M.Com. (Financial Management)
This paper studies the effects of bull and bear market states on the profitability of a
momentum investment strategy. That is, a strategy that buys past winners and sells past
losers is simulated over the period 3 July 2002 to 8 August 2012 and its profitability is
reviewed in light of bull and bear sub-periods. Such an investment strategy has been shown to yield abnormal returns in several markets around the world, including the South African stock market. By doing so, these studies challenge the efficient market hypothesis, a central and widely accepted hypothesis within traditional portfolio theory.
There are many theories that have been used to explain why abnormal profits are
achievable using a momentum investment strategy. By determining the effects of bull and bear market states on the profitability of a momentum investment strategy, this paper
provides some insight into which theories, if any, are most relevant to the South African
stock market context. It is found that on average, a momentum portfolio yields abnormal returns over the full sample period, with the chief driver of these returns being the winner component of the portfolio. When broken into bull and bear sub-periods, it was found that a momentum investment strategy only yields abnormal returns during a bull period, whilst these abnormal returns became negative during a bear period.
These results are consistent with one efficient market hypothesis explanation and two
behavioral models presented in past studies. The results indicate that the market may be efficient and that changes in macroeconomic risk are the cause of momentum profits.
However, insofar as the macroeconomic risk explanation is inaccurate, these results support the behavioural models of Daniel, Hirshleifer, and Subrahmanyam (1998); and Hong and Stein (1999). Both these models predict that momentum returns will be strongest during bull periods.