CXO Advisory recently published another study on momentum (otherwise known as relative strength) and style rotation. Not surprisingly, their conclusion was:
In summary, a simple style momentum strategy implemented with ETFs may perform well compared to the overall stock market and individual style ETFs.
Since we have been using style funds in some of our relative strength strategies for years, we could have told you the same thing, but it is always nice to have some validation by a completely independent party.
Relative strength is an incredibly adaptable method. We’ve demonstrated in our own white papers that it works nicely with stocks and asset classes. It works for industry rotation and style rotation. There is lots of third-party validation as well, whether from CXO Advisory here, other practitioners, or academics.
One of the things I particularly like about relative strength is that it can deal with a disparate basket of assets, which is considerably more difficult with other proven return factors like deep value. Value is not too tricky when comparing two similar assets, like two stocks. If you want to get more sophisticated, you can even build a complicated model to determine if stocks are cheaper than bonds. But how easy is it to determine whether crude oil, Apple Computer, or emerging market debt is cheapest? The assets and the metrics typically used to value them are not universal. With relative strength-no problem. It’s not difficult to determine which is the strongest asset and it can be done on an apples-to-apples basis.
