Systematic Relative Strength

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I’ve always said that relative strength investing appeals to pragmatists. This article by Morningstar only strongly confirms that position.

Yesterday’s The Wall Street Journal featured an unusual teaser: “Thumbs Up For Technical Analysis.” In the article, Wasatch Funds president Sam Stewart described his company’s increasing use of price-based signals with stock selection. “We used to be 100% fundamental analysis,” Stewart told the Journal. Now the firm reviews “several technical indicators.”

It’s been a while since I’ve seen a portfolio manager confess to using technical analysis. Well, not using that word.

Picking stocks because of their price movements fell into academic disfavor in the 1960s, when mainframe computers gave professors the ability to collect and crunch large data sets. The University of Chicago’s Gene Fama showed that past stock prices had little if any relationship to future prices. Since then, academics have conducted many follow-up studies, nearly all reaching the same conclusion. Among the ivory towers, “chartist” is not a compliment.

The reality is that many academics have long researched and published studies on price momentum and practitioners have long been applying relative strength analysis to portfolio management. Click here for a list of some of the best known white papers on the subject. Also, click here for a white paper written by our own John Lewis on relative strength investing. Selecting an effective investment methodology should be less about trying to employ an “ivory tower-approved” approach and more about what works. Less theory, more reality.

A relative strength strategy is NOT a guarantee. There may be times where all investments and strategies are unfavorable and depreciate in value. Past performance is no guarantee of future returns. Potential for profits is accompanied by possibility of loss.