Production Complementarity and Momentum Spillover Across Industries

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.