Systematic Relative Strength

The spring and summer box office has not been kind to many A-list movie stars like Denzel Washington, Julia Roberts, Eddie Murphy, John Travolta, Russell Crowe, Tom Hanks, Adam Sandler, and Will Ferrell as discussed in this recent article in The New York Times. Movies headlined by those stars have earned only a fraction of the cost of producing them. However, Brad Pitt has been one A-List movie star to show that he can still open a movie and justify A-list-type money. It has largely been a number of lesser-known actors, like Shia LaBoeuf, Ed Asner, and Daniel Radcliffe, that have exceeded expectations at the box office this year.

A-list movie stars have long been measured by their ability to fill theaters on opening weekend. This NYT article provides insight into the current changing of the guard.

A-list status is not a permanent distinction in Hollywood or on Wall Street.

Wall Street also routinely identifies A-list stocks. For example, Microsoft outperformed the S&P; 500 by 9225% in the 1990s, but has underperformed the S&P; 500 by 23% so far in this decade. Investors who dragged their feet too long waiting for things to return to their previous state missed out on better opportunities elsewhere. Apple, for instance, underperformed the S&P; 500 by 124% in the 1990s, but has outperformed the S&P; 500 by 588% so far in this decade. (Disclosure: Apple is a current holding in one of our Dorsey Wright managed products)

Relative strength excels by constantly adapting to the marketplace. Our models are not susceptible to the sentimental attachment associated with winners of past decades. Rather, our models are only attached to securities as long as their relative performance justifies their place in the portfolio.

“Every big idea that works is marked by simplicity, by clarity. You can understand it when you hear it, and you can explain it to people.” —Peggy Noonan, Wall Street Journal

Relative strength investing is just such an idea that works, is marked by clarity, and can be easily explained.

Most investors find investing to be incredibly complex. For an experiment, ask 10 investors what makes a stock go up or down and observe the disparity in responses. Some may say that it is the earnings of the company that determine the stock price. Other responses may focus on the perceived value of the company, a good story of the company’s prospects, market psychology, the overall health of the economy, availability and cost of money, fads, pronouncements of the President or Chairman of the Fed, analyst ratings, share buybacks, dividends, mergers and acquisitions, or speculation of the price itself.

Without minimizing the influence of any of these factors, a technician looks at the bigger picture to conclude that stock prices change every day and over time because of all of these reasons and more. In any given period, buyers and sellers of securities will be influenced more by some factors than others. The culmination of all of the factors influencing the buying and selling decisions of investors tends to cause prices to move in trends– often multi-year trends. Relative strength simply provides a framework for ranking securities by the strength of those trends and investing in the strongest of those trends.