Banks, for more than a year now, have been reducing the amount of lending they do. It may be because there are very few creditworthy borrowers, or it could be that banks have decided they need to shore up their own balance sheets and take more reserves against bad debt. Whatever the actual reason, it’s very difficult to keep the economy growing when many companies do not have access to capital.
Rationing of credit may act to differentiate companies that can still thrive in this environment from companies that will struggle to have enough cash flow to stay afloat. Markets where there are stark differences between the best stocks and the worst stocks are often markets in which relative strength shines as a strategy. Relative strength can help locate the strong companies and avoid the weak ones—and in the meantime, the market return is an average of the two. If the trend continues, we may begin to see high relative strength names outperform on a more sustained basis than the week-to-week choppiness we have seen so far.
