“Past performance is not indicative of future results.” While true of any investment strategy, that disclaimer can be extrapolated to imply that, on a market level, past movements tell us nothing about future ones. But, is that fact or fiction?
Trends and Their Persistence
Trends are sustained market price movements, up or down, over time. For decades, trend followers have systematically captured these moves, believing that trends represent a weak but persistent, and therefore exploitable, market effect. The existence of this effect is often attributed to behavioural dynamics such as herding and ‘fear of missing out’, as well as structural factors like economic cycles and ripple effects or feedback loops from major events.
Crucially, trends can emerge in any market, at any time. This underpins a core principle of trend following: trade a broadly diversified portfolio to maximise the opportunity set.
Measuring Market ‘Trendiness’
A useful way to assess the persistence of market behaviour is to examine the relationship between market returns and their recent history. In the context of trend following, positive correlations indicate that markets have tended to continue moving in the same direction as their recent, or lagged, past. The strength of this relationship can vary depending on the timeframe and market environment being considered. Figure 1 illustrates the average correlation between next-day returns and the mean return over the lookback window, across a diversified basket of markets, and for three different lookback horizons. It reveals two key insights:
- Trends are persistent: measures of correlation are positive across most periods and timeframes, indicating that sustained directional moves have been a recurring feature of markets over time.
- Trends are not consistent: some periods and timeframes exhibit a stronger tendency for sustained market moves than others, creating a more favourable environment for trend-following strategies.
The post-GFC period was defined by quantitative easing and zero interest rate policies and, as we see here, this period saw fewer than normal trending opportunities. Therefore, consistent with greater correlations signalling a strong trend environment, it may be no surprise that this period proved challenging for major trend following CTAs and was coined the CTA winter.
Figure 1: Mean half-decade correlations of market returns across three different timeframes
Why Trends Endure?
Returning to the initial statement: past performance is not indicative of future results. According to the Efficient Market Hypothesis, no - market prices should follow a random path. Yet behavioural biases, information gaps, and economic cycles continue to drive market inefficiencies. We still observe positive correlations, or non-random relationships between past and future market price moves, creating opportunities for a trend following strategy. The claim that a market’s past returns contain no information about its future returns is fiction. Just as trend following has thrived through shifting regimes and revolutions, these inefficiencies, and the opportunities they bring to those patient and disciplined enough to capture them, don’t appear to be going anywhere.
Insight Paper Disclosures
PAST PERFORMANCE IS NOT INDICATIVE OF FUTURE RESULTS. For Illustrative purposes only. Important performance information, investment risks and legal and regulatory disclosures applicable to Aspect Capital programmes can be found [here].
