How hard is it to hold onto the big winners? Michael Batnick takes a look a volatility characteristics of this decade’s best stocks:
The other day I looked at a common theme among the decade’s biggest winners; they tended to be very expensive relative to their peers based on traditional valuation metrics. Today I want to look at another trait these winners share, volatility and big drawdowns.
A few things really stand out in this table.
- Nine of the ten biggest winners were all cut in half. Granted, the S&P; 500 was as well, but the point is that even the best stocks gave investors plenty of sleepless nights.
- Even though these winners returned 23x what the S&P; 500 did, only Apple and Priceline hit all-time highs more often.
- The average standard deviation for these stocks was more than twice that of the S&P; 500. No pain, no gain.
- These stocks spent on average 34% of the time in “bear market territory.” That’s pretty wild. One out of every three days these stocks were at least 20% off their all-time high.
The point of this data is not to suggest that all stock pickers suffer 50% drawdowns. The message is that if you’re looking at long-term charts and and playing the coulda, woulda, shoulda game, don’t kid yourself, it’s never as easy as it looks.
Buying stocks with high relative strength is one thing. Having the ability to hold on to them and knowing when to get out is quite another. In fact, most investors probably can’t/won’t hold onto a basket of high relative strength stocks if the entire basket of stocks had double the standard deviation of the S&P; 500. However, when you look at the standard deviation of our PowerShares DWA Momentum ETF (PDP) compared to the S&P; 500, the standard deviation of our momentum index is only slightly more:
*Source: Yahoo! Finance. Based on monthly returns, price only, not inclusive of dividends, 4/07 – 11/15
What accounts for the fact that PDP’s standard deviation is only modestly more than the S&P; 500 even though it is investing in stocks that have high momentum? First, even if the standard deviation of each of the individual stocks in the index is high, the standard deviation of the entire index will likely be much lower than the standard deviation of the individual stocks because all 100 stocks in the index not are likely to be perfectly correlated. Also, it is worth noting that it is very possible for stocks with lower standard deviation than the market to have favorable relative strength, especially in environments when equities as an asset class are performing poorly.
There is also something else at work as it relates to the PowerShares DWA Momentum Index (and other indexes constructed using Point & Figure relative strength). One of the criteria for inclusion in the DWA Technical Leaders Index (index for PDP), is that a stock be on a relative strength buy signal AND in a column of X’s. This essentially acts as a trailing stop to help us get out of high momentum stocks that have huge reversals. See below:
The PowerShares DWA Momentum ETF (PDP) is rebalanced on a quarterly basis, so it is possible that a stock reverse to a column of O’s on its relative strength chart mid-quarter and have to wait until the end of the quarter to get removed from the index, thus allowing it more time to underperform even more. I wanted to make that point so nobody mistakenly thinks that a stock will get kicked out of the index the moment the reversal takes place. That said, we are of the belief that this requirement that a stock be on a relative strength buy signal AND in a column of X’s helps address some of the volatility concerns that some may have of a momentum strategy. Learn more about PnF relative strength best practices in Point and Figure Relative Strength Signals, by John Lewis, CMT, which was published last June.
The relative strength strategy is NOT a guarantee. There may be times where all investments and strategies are unfavorable and depreciate in value. See www.powershares.com for a prospectus on PDP.
