A laggard rally always produces quite a few crosscurrents that makes using an RS strategy very difficult. Many of the big returns since the market low have been in the beaten down Banking stocks. That group has been getting quite a bit of media attention (both good and bad) during their decline and subsequent ascent. Whenever the media focuses on something it often makes it difficult to find the forest through the trees! How well have these stocks really done?
We track a number of RS factors here. One set we track is simple price return over X months. While very simple, this type of factor is used extensively in academic research so it makes sense to track them. The periods we will look at for this exercise are 3 months, 6 months, 9 months and 12 months. We do track a 1 month RS factor, but everyone’s research (including our own) indicates a 1 month RS factor is a sure way to underperform over the long term so we will exclude it. The best returns usually come from the 6 to 12 month periods. In addition to better returns, the longer RS measures tend to have much less turnover compared to the shorter measures.
The chart below shows all of the Banking stocks in our universe that are in the top quartile for 3 month return. We have also included the percentile rankings for 6, 9, and 12 months.
Keep in mind that at a 3 month RS interval there is a ton of turnover. Another way of looking at it: there are a lot of whipsaws. More often than not, buying securities in the top ranked quartile or decile based on a 3 month trailing return doesn’t work out. Sometimes it does; we won’t know for sure in this case for another few months.
Also notice the ranks on the longer term RS factors. Many of these stocks are still in the bottom decile on a trailing 12 month return. If you’ve owned these stocks for any length of time you still aren’t happy. WFC and JPM score well out to a 12 month horizon, but even those two stocks don’t score that well on 6 and 9 month lookbacks. The ranks are all over the place! If you’re using a very short term RS factor you might be picking some of these stocks up already. However, using a very short term RS factor doesn’t test as well over the long term as longer term lookbacks.
So what do you do about this? Well, I’m not sure a whole lot can be done. We know there are quite a few whipsaws at lookbacks of 3 months and shorter. This could be one of those times. If not, and these stocks keep moving higher, they will eventually find their way into the upper ranks of the longer term RS factors. These are the areas that have proven to be more durable over time. It’s very tricky to make tweaks to your strategy based on short-term performance. Usually you make the change at the wrong time. When you have a long term factor that has the proven ability to find and exploit trends you have to accept the short term gyrations that the market throws at you.
Posted by John Lewis 
