Industry Momentum: The Role of Time-Varying Factor Exposures and Market Conditions

Abstract

This paper focuses on momentum strategies based on recent and intermediate past returns of U.S. industry portfolios. Our empirical analysis shows that strategies based on intermediate past returns yield higher mean returns. Moreover, strategies involving both return specifications exhibit time-varying factor exposures, especially when applying the Fama and French (2015) five-factor model. After risk-adjusting for these dynamic exposures, the profitability of industry momentum strategies diminishes and becomes insignificant for strategies based on recent past returns. However, most strategies built on intermediate past returns remain profitable and highly significant. Further analyses reveal that industry momentum strategies are disrupted by periods of strong negative risk-adjusted returns. These so-called momentum crashes seem to be driven by specific market conditions. We find profits of industry momentum strategies to be related to market states and to the business cycle. However, there is no clear evidence that industry momentum can be linked to market volatility or sentiment.

Keywords: Industry momentum, recent past returns, intermediate past returns, time-varying factor exposures, market conditions

JEL Classification: G11, G12, G14