Momentum Investing: Why Does Seasonality Matter for Momentum?

Momentum Investing: Why Does Seasonality Matter for Momentum?

November 30, 2015 Research Insights, Momentum Investing Research
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(Last Updated On: January 18, 2017)

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.

Alpha Highlight:

The free market for academic research ideas is extremely competitive. If you have an idea–and there is a dataset associated with the idea–one can be (almost) certain that there is a paper written on the subject and/or the idea was already tested and the t-stats weren’t high enough for publication (sad, but true).

The paper below is–unfortunately–an example of research competition…

Around 4 years ago, Jack and I started working on our “unique” idea of examining how tax-loss selling and window-dressing would affect a momentum strategy. We generated all of our results and we thought we were on our way to another academic publication. What excited us even more was the fact that this idea had never been published in a top-tier academic journal (e.g., The Journal of Finance, Journal of Financial Economics, Review of Financial Studies). Of course, as a last check we reviewed the “practitioner” journals to make sure it hadn’t been covered (e.g., FAJ, Journal of Portfolio Management). Turns out Richard Sias had already published the paper in a well-known practitioner journal, the FAJ, back in 2007! Jack and I were disappointed, but also happy, because our robust momentum seasonality findings had been confirmed by an independent party. We were also surprised that despite how much momentum seasonality matters to momentum strategies, research in top-tier academic journals on momentum had rarely even considered seasonality. Clearly, the professors aren’t reading the practitioner journals!

Enough about back story, what drives momentum seasonality?

Window Dressing

Sias hypothesizes that the results above are due to window dressing.” Window dressing, for those who are unfamiliar with the term, is an odd behavior exhibited by professional money managers who cater to less sophisticated clients.

In the retail business, “window dressing” refers to the practice of arranging merchandise in a store window to make it appear as attractive as possible. This brings customers in the store, even if the merchandise is not as good as it looks in the window. In the financial services industry, managers can similarly arrange their merchandise.

Here is how it works: The manager knows that they must report their holdings on quarterly and/or annual statements and these statements will get mailed to their clients. But the last thing they want their clients to see on those statements is their trash stocks that underperformed the market. You don’t want these stocks in the “window” people will be viewing. To manage around this scenario the manager will sell their “black eye” stocks and buy all the recent winners. Voila! The window now looks much more enticing.

Obviously, window dressing is not going to be a cure for bad performance, but the hope is that this activity will at least make them appear to have been doing something reasonable, and reduce client questions when they receive their statements.

Consider the two scenarios:

  • “Geez, you underperformed by 10%. And wow, you owned Blackberry? …Why do you own that horrible stock?! You really must be an idiot.”
  • “Geez, you underperformed by 10%. And wow, you owned Apple? …That is a good stock that has done well. You seem like a good manager so I guess you had an unlucky stretch.”

Clearly, the manager would much rather field the second question, and not the first question. And because annual reports are much more “available” than quarterly reports, the window-dressing effect is hypothesized to be more powerful surrounding the annual report.

Tax-motivated Trading

One our favorite topics is the value of tax minimization, so we are predisposed to believe in the tax-motivated momentum seasonality story. The story works as follows: At year end, taxable investors would rather jump off a bridge than realize a large capital gain in November or December. Similarly, taxable investors eagerly realize losses on big losers so they can use the tax-losses to offset gains in other areas of their portfolio. Mechanically, holding on to high momentum stocks and aggressively selling low momentum stocks, leads to an enhanced momentum effect towards the year end.

Great theories, what are the results?

The window-dressing hypothesis outlined above suggests that the momentum effect will be concentrated in quarter-end periods. One would also expect the window-dressing effect to more extreme for those stocks with higher institutional trading versus lower institutional trading. Why? Because it is the institutions-the funds-who have the window dressing incentive. If a stock is owned mostly by retail investors, those investors have no window to dress.

The tax-motivated hypothesis runs parallel to the window-dressing hypothesis and suggests that the year-end momentum effects will be extreme because there is 1) window-dressing and 2) tax-incentives at play.

Sias finds strong evidence for both the window-dressing and tax-motivated hypotheses. Specifically, after excluding January, 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. That’s a difference of over five times. The pattern was stronger for stocks with high levels of institutional trading and was particularly strong in December.

Let’s review two figures from the paper:

  • Figure 1: From 7/1963 to 3/1984, momentum profits from non-quarter-ending months (ex January) were almost the same as momentum profits from quarter-ending months. However, from 4/1984 to 12/2004, we can see strong momentum seasonality for quarter-ending months.
  • Figure 2: From 4/1984 to 12/2004, December exhibits the largest momentum profits (5.52%), followed by June (3.48%) and September (2.65%). Losses in January are huge…
momentum seasonality
The results are hypothetical results and are NOT an indicator of future results and do NOT represent returns that any investor actually attained. Indexes are unmanaged, do not reflect management or trading fees, and one cannot invest directly in an index. Additional information regarding the construction of these results is available upon request.

The evidence is pretty clear that seasonality plays a very role in momentum-based stock selection strategies. As an aside, we have extended these results to international markets and find strong evidence for the window-dressing hypothesis, but limited evidence for the tax-motivated hypothesis, which makes sense because tax regimes are different around the globe.


We won’t waste words here and will defer to Sias, who says it best:

Investors attempting to exploit return momentum should focus their efforts on quarter-ending months…  — Sias (2007)

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About the Author

Wesley R. Gray, Ph.D.

After serving as a Captain in the United States Marine Corps, Dr. Gray received a PhD, and was a finance professor at Drexel University. Dr. Gray’s interest in entrepreneurship and behavioral finance led him to found Alpha Architect. Dr. Gray has published three books: EMBEDDED: A Marine Corps Adviser Inside the Iraqi Army, QUANTITATIVE VALUE: A Practitioner’s Guide to Automating Intelligent Investment and Eliminating Behavioral Errors, and DIY FINANCIAL ADVISOR: A Simple Solution to Build and Protect Your Wealth. His numerous published works has been highlighted on CBNC, CNN, NPR, Motley Fool, WSJ Market Watch, CFA Institute, Institutional Investor, and CBS News. Dr. Gray earned an MBA and a PhD in finance from the University of Chicago and graduated magna cum laude with a BS from The Wharton School of the University of Pennsylvania.

  • Andrew M.

    Are the non quarter end months (ex Jan) even statistically different from 0?

  • matt

    great post! how do you implement this in a low turnover way? changing your weight on momentum before/after quarter end will itself tend to incur more transaction costs/taxes….

  • Doubtful. Even if they were, they aren’t economically different than 0!

  • Well, here is how we do it–rebalance quarterly, but optimize the rebalance to exploit window-dressing/tax.

    re Tax: run the strategy via structures that are super tax-efficient…if you don’t have any tax-structuring, then you’d never want to do any active strategy, frankly…b&h tax-deferred Vanguard is too tough to beat on an after-tax, after-fee basis.

  • Phil Whittington

    But hang on, we effectively want to front-run the window dressers right? So we need to buy before they do?

    If that is right, don’t we want to buy the month before quarter end?

  • Yes, you got it. You want to make sure you front-run the window-dressers…so get your rebalance on at least a few weeks prior to the quarter ending date.

  • Phil Whittington

    Great, thanks.

  • Damian Bergamaschi

    Does this data suggest a mean reversion edge in January? It would make sense with the original hypothesis; people waiting to enter what they just sold due to the wash sale rule and fund managers shifting back to their focus as stated in the prospectus.

  • yes, l/s mom is actually negative in january

  • Great paper on the subject:
    We’ll highlight in detail later. h.t. to one of the authors who happens to also be a blog reader.

  • David

    Thanks Wesley. I’m not sure what kind of point I’m trying to make, but I note there are the following related seasonal and factor anomalies: momentum is stronger with small caps, small caps outperform large caps in January, large caps are more susceptible to window dressing because of their greater institutional following. So what’s the takeaway here? Concentrate on small cap momentum, except at end of quarters, and especially into December?

    Btw, love your general approach, but I have trouble reading tables. Any chance of adding cumulative profit charts as part of your regular analysis?

  • Jerry

    Could you please explain why January is such a loser month.

  • Vedast Sanxis

    So I guess December is the best month to look for value stocks.

  • Jack Vogel, PhD

    best month to look, January is the best month to invest based on the evidence in this paper.

  • Jack Vogel, PhD

    One theory is that the trading is due to tax-loss selling. So that near the end of the year (December) everyone sells their losing stocks and holds onto their winning stocks for tax purposes (Momentum long/short works very well in December). In January, when they rebalance their portfolio, they buy losing stocks and sell some of their winning stocks — this drives up prices of low momentum stocks and prices down for high momentum stocks.

  • Jack Vogel, PhD

    This is our summary of a paper by Richard Sias — so we did not create the tables.

    The two main takeaways are the following:

    1) Momentum long/short strategies work the best in quarter-ending months (March, June, September, December) due to window dressing.
    2) Momentum long/short does not work in January; Momentum long/short works the best in December — these are most likely driven by tax-loss selling.

  • Vedast Sanxis

    Yes, I mean investing after tax harvesting and window dressing have been done, therefore at the end of December.

  • Jack Vogel, PhD

    Yep — that is correct

  • David

    Thanks Jack. I clearly didn’t express myself clearly enough, considering your reply. I understand that this post was a summary of another paper, and I understand fully all the results as presented.

    Instead, I was making a general comment on related phenomena. Firstly, there is a January effect for small caps (small outperform large); secondly, Asness and others note that small momentum outperforms large momentum. Therefore, I wanted to tease out the mixed effects.

    Regarding tables, it was a general comment about how your website typically presents its information. I understand that different people like to receive their information in different formats (my former boss only liked tables, hated charts), but it’s quite common for other quant focused sites to present cumulative profit charts. Hence my query.

  • David

    Jack, I realize I again haven’t made myself plain. Re. small cap momentum, I’ve always assumed (based on my own work) that it outperformed large cap momentum year around. Now I’m wondering whether this is true, or whether large cap mom keeps pace with small cap mom until end of quarter effects kick in. I haven’t done any work personally on seasonal effects, so I thought you might know off the top of your head. Does any of this make sense?

  • Jack Vogel, PhD

    Good question, one we have not directly tested (small cap momentum and large cap momentum and specifically how they work in quarter ending months). For a few reasons, we focus our research on mid / large cap stocks.

    We generally prefer to show tables instead of charts, as over long time periods the charts may look incredible. but not show all the “bad” stuff for a strategy (such as high tracking error, large drawdowns, large volatility).

  • Mark

    Another great post.

    I’m curious how you would implement this? Do you only buy on quarter end months (March, June, September, December) hold for one month then go to cash? Or do you hold for the quarter? Or just buy the market in non-quarter ending months?

    My understanding is that the momentum strategy works best with a one month holding period, so holding for the quarter would degrade performance.

  • Jack Vogel, PhD

    Based on the evidence in the paper, to take advantage of the window dressing, one would rebalance on the end of Feb, end of May, end of August, and end of November. While you are correct that momentum returns before fees are highest when rebalancing monthly, there are fees associated with monthly trading. So a decent strategy would be to rebalance the end of Feb, end of May, end of August, and end of November and hold for the quarter. Another approach (as you point out) is to hold a momentum portfolio for quarter-ending months and then buy the market the other 8 months.