Industry momentum and reversals in the European markets

Both momentum and contrarian investment strategies are considered as stylized facts in the vast literature that studies the performance of securities, such as stocks, currencies, corporate bonds, futures and forward contracts, being referred as securities’ “relative performance” (Jegadeesh and Titman, 1993). This paper examines momentum and reversal patterns of industrial portfolios of the stocks traded in 14 European markets, based on cross-markets industrial portfolios. Our findings document the presence of significant within-industry short-term reversals, which are driven by the bottom 20% of capitalized firms. An implementable contrarian investment strategy yields up to 5% annually for selected portfolios of real estate and finance stocks. In contrast, we also find evidence in favor of across industry short-term underreaction, thus a profitable momentum trading strategy can be implemented. We link this underreaction with the notion that stock markets react with a delay to incoming information. This part of work is directly motivated by Hong et al. (2007, 2014) and Tse (2015) in testing whether there is a delay in the diffusion of information between industry sectors and the market, through a forecasting exercise of the market. In addition variables suggested in previous literature we also add the state of the market as a control variable. We employ OLS and Markov switching models and find that some industry portfolios do have predictive power over Eurostoxx 600. Results are mostly driven by industries with higher market capitalization, while industries located in the South convey more predictive information than industries located in the North. We do not find any significant changes in the results when we take into account the state of the market.