In the ever-evolving landscape of investment strategies, understanding the drivers behind performance is crucial. While traditional assets like stocks and bonds have well-documented relationships with economic factors, the dynamics of strategies such as time series momentum are less understood. In their paper “Time Series Momentum and Macroeconomic Risk,” Mark C. Hutchinson and John O’Brien delve into the intricate relationship between time series momentum returns and the macroeconomic environment.

The authors analyzed a comprehensive dataset spanning from 1950 to 2014, covering exchange-traded futures contracts and synthetic forward contracts across commodities, government bonds, equity indices, and currency crosses. They constructed time series momentum portfolios using a 12-month look-back period and a one-month holding period, weighting positions proportionally to their momentum signals and inversely to their volatility. This approach ensures balanced risk management and aligns with common practices in momentum strategy implementation.

The research reveals that time series momentum exhibits robust performance across various economic cycles, challenging the notion that it primarily thrives during equity bear markets. One of the key insights is the strategy’s relationship with economic uncertainty.

The natural logarithm of cumulative excess returns of the diversified time series momentum portfolio from January 1950 to September 2014, net of transaction costs and gross of fees.

Figure 1 illustrates the steady upward trajectory of the cumulative excess returns over six decades, underscoring the strategy’s ability to generate consistent positive returns. This performance spans multiple market cycles, highlighting the strategy’s resilience and potential as a valuable component in diversified portfolios.

Based on the methodology defined in Bali et al. (2014). Labels correspond to financial crises identified in Hutchinson and O’Brien (2014).

Figure 2 presents the economic uncertainty index, revealing an inverse relationship between economic uncertainty and time series momentum returns. The strategy tends to perform better when economic uncertainty is lower than average. This finding suggests that time series momentum is sensitive to macroeconomic conditions, performing optimally during periods of relative stability.

The insights from Hutchinson and O’Brien’s research have significant implications for return stacking, a portfolio construction technique that combines multiple, often uncorrelated, investment strategies to enhance diversification and improve risk-adjusted returns. By incorporating time series momentum into a return stacked portfolio, investors can leverage its unique performance characteristics.

As discussed in our article on return stacking, combining strategies like time series momentum with traditional assets can improve portfolio efficiency. The strategy’s robustness across different economic cycles makes it an effective “all-weather” diversifier, potentially reducing overall volatility and enhancing returns.

Additionally, using leverage in a controlled manner can improve capital efficiency, allowing investors to gain exposure to time series momentum without a significant capital outlay. This efficiency is key in constructing return stacked portfolios that aim to maximize yield and risk-adjusted returns. Moreover, time series momentum aligns with trend following strategies, which capitalize on sustained market movements. For more on this, see our article on managed futures and trend following.

Furthermore, the relationship between time series momentum and economic uncertainty offers opportunities for dynamic allocation. During periods of low economic uncertainty, increasing exposure to time series momentum could enhance returns. This approach complements strategies that focus on generating consistent income streams, such as those described in our piece on managed futures yield and carry.

Hutchinson and O’Brien’s exploration of time series momentum in the context of macroeconomic risk provides valuable insights for investors seeking to enhance portfolio diversification. By demonstrating the strategy’s robust performance across economic cycles and its sensitivity to economic uncertainty, they offer a compelling case for its inclusion in sophisticated portfolio strategies.

Incorporating time series momentum into return stacked portfolios can contribute to portfolio stability and improved risk-adjusted returns. The strategy’s unique characteristics, combined with a macro-informed approach, can help investors navigate varying market conditions more effectively.

As the investment landscape continues to evolve, embracing strategies that leverage both empirical performance and macroeconomic insights will be essential. Time series momentum, when integrated thoughtfully into a broader portfolio framework, has the potential to enhance diversification and contribute to long-term investment success.