Systematic Relative Strength

The real key to making money in stocks is not to get scared out of them.
-Peter Lynch

One of the most difficult tasks every investor faces is dealing with adversity. Dealing with a strong period of performance is easy, but handling downturns or periods of underperformance is always exceptionally difficult. Relative strength strategies, after having gone through a sustained period of outperformance from 2007 to mid-2008, are currently in a funk. We’ve commented a lot on the recent laggard rally, but that doesn’t mean it’s easy to sit tight.

Peter Lynch’s comment, I think, is very valid-but, of course, it is easier said than done. One thing that might give some comfort is the nature of our systematic process. Our systematic strategy is rules-based and adaptive. While relative strength strategies can go in and out of favor (as now), they typically do not stay out of favor for significant parts of the market cycle. A systematic process will not make giant swings in asset allocation that are emotional reactions to the current market environment. Instead, it will steadily grind away and continue to try to adapt as trends and market themes change over time.

Relative strength strategies have historically outperformed over time, and not getting scared out of the strategy during a period of under-performance is the best way to take advantage of that characteristic.