Chan et al. propose a potential explanation for the relative longevity of
the predictive component of the different types of information. The earnings
momentum strategies are based on the performance of near-term income—
the surprises in quarterly earnings or changes in analysts’ forecasts of earn-
ings for the current fiscal year. In contrast, when stocks are ranked on the
basis of high or low prior returns, the extreme portfolios comprise stocks
for which the market made large revisions in its expectations for the com-
pany’s future outlook. The stocks in the highest-ranked portfolio in the re-
turn momentum strategy rose in price by roughly 70 percent, on average,
and the stocks in the lowest-ranked portfolio fell in price by about 30 per-
cent, on average, over the ranking period. Changes of this magnitude are
unlikely to have arisen solely from quarter-to-quarter news in earnings.
Chan et al. report that the corresponding past six-month returns of the
portfolio ranked highest (lowest) by analyst revisions is about 25 (−7 per-
cent). Because the reappraisal of market beliefs for the price momentum
portfolios is larger, and given that the market’s adjustment is not immedi-
ate, it is not surprising that the spread in future returns is larger for the
price momentum strategy.
7 .ConclusionUnderlying the efficient market hypothesis is the notion that if any pre-
dictable patterns exist in returns, investors will quickly act to exploit them,
until the source of predictability is eliminated. However, this does not seem
to be the case for either past returns or earnings-based momentum strate-
gies. Both strategies have been well-known and were well-publicized by at
least the early 1990s, but both continue to generate profits.
The momentum-effect is quite pervasive and it is unlikely that it can be
explained by risk. The momentum strategies have generated consistently
positive returns for at least the past sixty years in the United States, includ-
ing the 1990s, a period that was not included in the original momentum
tests. Momentum profits have also been found in most major developed
markets throughout the world. The only notable exception is Japan, where
there is very weak and statistically insignificant evidence of momentum.
We would argue that the momentum-effect represents perhaps the
strongest evidence against the efficient markets hypothesis. For this reason
it has attracted substantial research. At this point, we have a number of in-
teresting facts to explain it as well as several possible theoretical explana-
tions. However, financial economists are far from reaching a consensus on
what generates momentum profits, making this an interesting area for fu-
ture research.
MOMENTUM 385