Jim O’Shaughnessy’s April 2011 market commentary provides an interesting analysis of the real returns to stocks and bonds during different inflation environments. Of particular interest to relative strength investors is his analysis of the performance of high momentum stocks. As shown in the table below, the stocks with the highest 6-month price momentum outperformed the benchmark in each of the inflation regimes during the observation period of 1926-2010.
(Click to Enlarge)
Some may look at the government statistics today and argue that inflation is not currently an issue. However, it is well documented that the United States government has revised its method of calculating inflation several times over the years, which has had the effect of understating inflation. According to Shadow Stats, if the government measured inflation on its pre-1982 methods, it would be running at 11.6% percent right now, or 7.3% using the pre-1998 calculations. In other words, we are arguably already in a period of high or severely high inflation.
O’Shaughnessy covers the performance of high momentum stocks during the last regime of severely high inflation (1973-1980):
As the upcoming Fourth Edition of What Works on Wall Street documents, the ten percent of stocks from our All Stocks universe with the highest six-month price appreciation earned a real (inflation-adjusted) average annual compound return of 15.66 percent, turning $10,000 invested on December 31, 1973 into $27,691 at the end of 1980.
Different inflation regimes provide headwinds for some companies and industries and tailwinds for others. The goal of relative strength strategies is to let relative price performance tell us which companies have the wind at their backs and are producing the best performance in the current environment. History suggests that relative strength strategies tend to do just fine in high inflationary environments.
Past performance is no guarantee of future returns.
[...] likely to own the leaders that have found a way to monetize the ensuing social and business trends. Historical studies reveal that stocks with high 6 month RS tend to significantly outperform during any market [...]