Causes and Seasonality of Momentum Profits

With Januaries (a month in which lagged “losers” typically outperform lagged “winners”) excluded, the average monthly return to a momentum strategy for U.S. stocks was found to be 59 bps for non-quarter-ending months but 310 bps for quarter-ending months. The pattern was stronger for stocks with high levels of institutional trading and was particularly strong in December. The results suggest that window dressing by institutional investors and tax-loss selling contribute to stock return momentum. Investors using a momentum strategy should focus on quarter-ending months and securities with high levels of institutional trading.Stocks exhibit return momentum: Lagged “winners” (i.e., securities in the top performance decile based on returns over the previous six months) tend to subsequently outperform lagged “losers” (i.e., securities in the bottom lagged six-month performance decile). Both tax-loss selling in December and window dressing by institutional investors in quarter-ending months may contribute to stock return momentum. In the case of tax-loss selling, investors (both individual investors and some institutional investors) may favor selling lagged losers in December to realize taxable losses and may avoid selling lagged winners in December to forestall recognizing taxable gains. This behavior may contribute to return momentum in December. In the case of institutional investors, their window-dressing behavior also may contribute to momentum-profit seasonality. At quarter-end, and especially year-end, institutional investors may want to abandon lagged losers to avoid reporting “embarrassing” stocks in their end-of-quarter or end-of-year holdings. Similarly, managers may buy lagged winners to appear as if they held respectable or “winning” stocks throughout the period.This study found that the profitability of momentum strategies in the past 20 years arose primarily from the last month of each quarter, which is consistent with the hypothesis that year-end tax-motivated trading and institutional window dressing contribute to stock return momentum. Momentum profits were, on average, negative when quarter-ending months (March, June, September, and December) were excluded from the sample. January, a month when lagged losers typically outperform lagged winners, explains part of the negative momentum profits for non-quarter-ending months. Even after excluding January from the sample, however, momentum profits from quarter-ending months averaged more than five times the momentum profits from non-quarter-ending months.The seasonal pattern was particularly strong in stocks with high levels of institutional trading and in December. The momentum-profit seasonality and the relationship between this seasonality and institutional trading suggest that tax-loss selling and institutional window dressing play substantial roles in driving stock return momentum. Investors attempting to exploit return momentum should thus focus their efforts on quarter-ending months and on securities with high levels of institutional trading.