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Earnings momentum methods made massive cash however at the moment are dropping the large mo’

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Earnings momentum strategies are a risky way to find your way into the upcoming corporate earnings season, which begins in mid-January.

I’m referring to strategies that favor the stocks of companies whose earnings growth is accelerating. Both theoretically and historically, stocks in such companies should outperform those with declining growth rates.

A perfect current example is Tesla TSLA, + 7.84%.
The result has been growing for several quarters: from a loss in 2019 to a profit of 25 cents per share, 44 cents per share and 76 cents per share in the first three quarters of last year. For the fourth quarter of 2020, which Telsa is expected to report on February 3, FactSet says Wall Street analysts agree that the company will post earnings per share of 96 cents.

Needless to say, Tesla’s stock price has risen in line with its earnings, with trailing 12-month earnings exceeding 737% (according to the FactSet).

Still, there are two main reasons I caution against relying on earnings momentum strategies when choosing which stocks to buy or sell in the upcoming earnings season.

The market reacts almost instantly to earnings surprises

The first is convenient: Wall Street reacts almost instantly to earnings surprises. By immediately I mean a matter of seconds. If you or I read about unexpectedly good earnings, it will almost certainly be too late to benefit from the news.

For example, imagine Tesla reported quarterly EPS on its February 3 earnings report well above the current consensus of $ 0.96. You can bet the stock will go up almost instantly. This rally would largely rule out any remaining upside that earnings momentum strategies were able to tap earlier.

This is what efficient market theorists tell us, inevitably with any strategy that has shown great historical prospects. As more and more investors pursue a strategy, they kill the goose that lays the golden egg.

This explains the deteriorating performance of what was previously the most successful earnings dynamic strategy in the newsletter industry. I am referring to the stock ranking system published by the Value Line Investment Survey. The newsletter reports every week on the 100 stocks (from a universe of 1,700 widely distributed issues) that have the greatest appreciation potential in the coming year. Although the newsletter’s ranking system is proprietary, we know that it is largely based on win surprises.

As you can see from the chart below, a portfolio of these 100 favorite Value Line stocks outperformed the S&P 500 SPX by a significant + 0.55% over the period from 1980 to early this century but has lagged since then. (Full Disclosure: Value Line is not among the newsletter publishers who have signed up with my performance monitoring company to review their returns.)

The value could be on the verge of outperforming growth

Another reason not to rely on earnings momentum strategies is that momentum strategies tend to perform poorly when value stocks, some predict, outperform growth stocks in 2021.

The negative correlation between value and momentum was documented a few years ago in a study published in the Journal of Finance. The past year was a case in point: the growth was negative and the momentum certainly developed well: the iShares MSCI USA Momentum Factor ETF MTUM (+ 1.65%) outperformed the S&P 500 by 10 percentage points.

Compare that to what happened in 2016, the last year that value relative to growth did really well. This year, the USA Momentum Factor ETF lagged the S&P 500 by 7 percentage points.

Of course, there is no guarantee that value will outperform growth this year. Similar predictions about the revival of value have been made every year since 2016, and so far they have not materialized. But value usually beats growth when the economy emerges from periods of economic downturn and many will blow the economy up this year as the pandemic is largely behind us.

In fact, according to fund flow data for December, there is evidence that this growth may have already started this conversion.

Bottom Line: Be my guest if you want to bet on which companies will beat the Wall Street consensus in their upcoming earnings reports. You will make a quick profit if you are right. But not if you wait for those earnings to actually be reported.

Mark Hulbert is a regular contributor to MarketWatch. His Hulbert Ratings track investment newsletters that pay a flat fee for testing. He can be reached at mark@hulbertratings.com

More: How To Make Money In 2021 – Follow These Three Stock Market Takeaways From Last Year

Also read: Why focusing on short-term results can short-circuit your investment and financial advice

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