Data are sourced from Input-Output Surveys of the Bureau of Economic Analysis, Compustat Historical Industry Segment database and CRSP. COMPL score is defined as the cosine similarity of two firms’ output flow vectors at time t. Each element of these vectors represents the proportion of firm i sales used by industry n.
ASSET CLASS: stocks | REGION: United States | FREQUENCY:
Monthly | MARKET: equities | KEYWORD: Momentum
I. STRATEGY IN A NUTSHELL
Invest in U.S. stocks based on top 2% production complementor returns. Go long high-return complementor stocks and short low-return peers. Value-weighted portfolio rebalanced monthly with six-month formation gap.
II. ECONOMIC RATIONALE
Delayed attention to production complementors’ fundamentals creates return spillovers. Investors’ inattention, stronger economic linkages, and higher arbitrage risk drive predictable momentum effects across connected firms.
III. SOURCE PAPER
Production Complementarity and Momentum Spillover Across Industries [Click to Open PDF]
Charles M.C. Lee, Stanford University – Graduate School of Business; Terrence Tianshuo Shi, Harvard University – Business School (HBS), City University of Hong Kong (CityU) – Department of Economics and Finance; Stephen Teng Sun, City University of Hong Kong (CityU) – Department of Accountancy; Ran Zhang, Renmin University of China – School of Business;
<Abstract>
Economic theory suggests production complementarity is an important driver of sectoral co-movements and business cycle fluctuations. We operationalize this concept by developing a measure of the production complementarity distance (COMPL) between any two companies. We find firms from different industries that are closely aligned in terms of COMPL exhibit strong co-movement in both fundamentals and stock returns. Further, we find a strong lead-lag effect in returns, such that a long-short strategy based on recent COMPL peer returns yields a monthly alpha of 137 basis points, with no reversals. This inter-industry momentum effect is not explained by common risk factors or other network-based effects such as industry membership, customer-supplier relations, and shared analyst coverage. We conclude cross-industry news transfer occurs along complementarity networks, but stock prices do not update instantaneously.
IV. BACKTEST PERFORMANCE
| Annualised Return | 9.9% |
| Volatility | 19.34% |
| Beta | N/A |
| Sharpe Ratio | 0.51 |
| Sortino Ratio | N/A |
| Maximum Drawdown | N/A |
| Win Rate | 71% |
