It is so easy to get caught up in the day to day outperformance or underperformance of our relative strength strategies. What do they currently own? Which positions are closest to being sold? What will replace them? All relevant questions for sure, but I find it helpful to take a couple steps back every now and again and look at a long-term look view of relative strength strategies. The RS Spread, shown below, offers a 25 year look at how the relative strength leaders have fared compared to the relative strength laggards.
The chart below is the spread between the relative strength leaders and relative strength laggards (top quartile of stocks in our ranks divided by the bottom quartile of stocks in our ranks; universe of U.S. mid and large cap stocks). When the chart is rising, relative strength leaders are performing better than relative strength laggards.
Source: Dorsey Wright, 5/23/90 – 11/20/15. Price return only, not inclusive of dividends or transaction costs.
- Over time, you’ve been much better off owning RS leaders as opposed the RS laggards
- The RS Spread doesn’t always go up. In fact, there have been a number of periods (often after major recessions and during the first 12 months of new bull markets) where RS laggards have actually had better performance. Those are often the environments where momentum investors are glad they also own some value strategies in their allocation.
- From late 2009 through the middle of 2014, the RS Spread chopped sideways. This was a period where most all stocks were going up, but the RS leaders weren’t necessarily doing any better than the RS laggards.
- For the last year and a half or so, RS leaders have been dominating the RS laggards.
What does this suggest about the future? Could the meaningful outperformance of the RS leaders over the last year an a half or so constitute some type of breakout in light of the previous extended period of similar performance between the RS leaders and laggards? I am inclined to think so. Hopefully, this provides some food for thought for those advisors having discussions with clients about putting new money to work.
This example is presented for illustrative purposes only and does not represent a past recommendation. The performance above is based on pure price returns, not inclusive of dividends or all transaction costs. Investors cannot invest directly in an index. Indexes have no fees. Past performance is not indicative of future results. Potential for profits is accompanied by possibility of loss. This analysis speaks only in generalities and may or may not be directly applicable to any particular investment strategy.