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Everyone loves an underdog, but doing so may have been costly recently.

For a long time, one popular method of portfolio management required taking profits in winners to lock in gains and reduce risk, while using some of those funds to buy laggards that nonetheless appeared to have strong fundamentals that could trigger a rebound. This contrarian rebalancing tactic of selling top performers to pay for new bets adds “modest value over the long run,” writes Trivariate Research President Adam Parker.

However, one big caveat is that this strategy isn’t a one-size-fits-all approach, and in momentum-driven markets—like the one that has been dominant in recent years—it’s actually a headwind.

That’s Parker’s conclusion after he backtested this contrarian rebalancing strategy alongside two others: buy-and-hold and momentum-based methods, the latter with positions increased as they outperform and reduced as they underperform.

He and his team selected 50 stocks at random from the 500 largest companies by market capitalization each month since 1999, assigning them equal starting rates. These portfolios were then updated daily for two years, and the process was repeated 200 times for each start month (transaction costs and taxes were excluded).

The results show that the standard contrarian rebalancing strategy of selling winners and buying losers holds up well over time, but we are in anything but ordinary times. In recent years, it has lost its edge, especially in tech, when momentum has carried the day. That much is clear from the Roundhill Magnificent Seven exchange-traded fund, which is up some 130% since spring 2023, despite its year-to-date declines. Betting against Nvidia has also been a fool’s errand in the past three years.

Parker’s research shows that the long-term standard contrarian approach works best when the market is in the down 20% to up 10% range, but with gains beyond that, “the value of buying losers and selling winners is negated.”

The S&P 500, of course, was up more than 20% in 2023 and 2024, and by nearly as much last year.

So what is an investor to do? Parker has four main takeaways. First, don’t trade too much; second, only buy losers when you are confident that a market bottom is close at hand and a big recovery will follow. He also warns that it’s extremely difficult to say when tech’s ability to skew toward momentum will end.

And finally, if investors “insist on buying laggards and selling winners, using fundamental overlays can be helpful. Overall, adding to stocks with forecasted revenue growth and gross margin expansion with upward revisions helps, and avoiding those with weak revenue growth and margin outlooks, with recent downward revisions, also helps. Within technology, avoid selling those with strong momentum.”

Buy low, sell high seems like timeless advice, but if recent years have taught us anything, it’s that nothing is sacred.

Write to Teresa Rivas at teresa.rivas@barrons.com

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