Meb Faber’s Momentum and Trend-Following Trading Strategy Analysis (Gold, Stocks, And Bonds)

Meb Faber, a famous money manager and writer, has several times stated he is a trend follower at heart. Back in 2015, he published an article about momentum and trend-following strategy called Meb Faber’s Three-Way Model in gold, stocks, and bonds– a model that Meb Faber (Mebane Faber) found in some research from Ned Davis Research. However, we would label the strategy more a momentum strategy than a trend-following strategy. How has this strategy performed and is it still working?

Yes, Meb Faber’s momentum/trend-following strategy in gold, stocks, and bonds is still working. The strategy is as simple as it gets: Initiate (or keep) a position if the monthly 3-bar moving average is above the 10-bar moving average. The strategy returned 13% annually from 1971 to 2015. We updated and backtested the strategy and show you the results after 2015.

Before we go on to explain Meb Faber’s momentum/trend-following strategy we start by explaining what momentum strategy investing is:

What is momentum in trading and investing?

Momentum investing is an approach that seeks to buy stocks with the best historical performance over a given period and then periodically rebalance the portfolio such that at any given time, it’s invested in the stocks with the highest momentum. Momentum is quite similar to trend-following strategies.

This approach is based on the momentum hypothesis, which believes that there is a strong correlation between 3-12 months historical return and 3-12 months future return. That is, stocks that performed the best over the medium term (3-12 months) are likely to continue performing well in the near future, say the next 3-12 months.

In backtests going back decades, even a century back, momentum has proven to be less significant for periods shorter than 3 months and longer than 12 months.

In one study, Alpha Architect analyzed stocks in the top 40% of the largest stocks on NYSE based on market value from 1974 to January 2016. They measured the return on each stock over the past 12 months and rebalanced the portfolio each month by investing in the top 10% stocks with the best price performance. They deducted 1% annually for transaction costs and another 1% for the annual management fee. Their findings showed an annual return of 14.4% against a 10.92% annual return for the S&P 500. This is a pretty significant improvement to buy and hold.

However, when you are testing the momentum anomaly you need to filter data for survivorship bias.