How hard is it to hold onto high relative strength stocks? Regarding high momentum stocks, The Motley Fool provocatively says, “Even with a time machine, a lot of people wouldn’t want to own the best-performing stocks.”
Monster Beverage (NASDAQ: MNST) was the best-performing stock from 1995 to 2015. It increased 105,000%, turning $10,000 into more than $10 million.
But this isn’t a retrospective about how you should wish you owned Monster stock. It’s almost the opposite.
The truth is that Monster has been a gut-wrenching nightmare to own over the last 20 years. It traded below its previous all-time high on 96% of days during that period. On average, its stock was 26% below its high of the previous two years. It suffered four separate drops of 50% or more. It lost more than two-thirds of its value twice, and more than three-quarters once.
With that commentary in mind, consider a relative strength chart of MNST for the last 10 of those 20 years (2005-2015):
The green-shaded areas are when MNST was on a PnF buy signal and the red-shaded areas are when MNST was on a PnF sell signal. When buy and sell decisions are driven by longer-term relative strength signals as opposed to a trend chart of the stock, investing in high momentum stocks becomes easier. Relative strength signals filter out much of the day-to-day noise that can give a discretionary investor an ulcer. Furthermore, putting all your eggs in one basket with an investment in one momentum stock is one thing, but investing in a basket of momentum stocks is quite another. Will the basket of high momentum stocks have a standard deviation higher than that of the market—most likely yes. However, due to the fact that it is highly unlikely that a basket of high momentum stocks will all have a correlation of 1, the entire basket or portfolio of high momentum stocks may not have a standard deviation much higher than that of the broad equity market over time. For example, consider the 5-year standard deviation of the PowerShares DWA Momentum Portfolio (PDP) compared to that of the S&P; 500:
Source: Morningstar, a/o 1/31/16
PDP’s standard deviation is 12.46% compared to 11.98% for the S&P; 500. Not nearly as scary as the momentum naysayers would have you believe. Don’t get me wrong, I’m not saying that investing in high momentum stocks is a walk in the park. I’m just saying that I believe it is worth it.
This example is presented for illustrative purposes only and does not represent a past recommendation. Dorsey Wright currently owns MNST. A list of all holdings for the trailing 12 months is available upon request. Dorsey Wright is the index provider for PDP. See www.powershares.com for a prospectus. Standard deviation figures are calculated using total returns, inclusive of dividends. The relative strength strategy is NOT a guarantee. There may be times where all investments and strategies are unfavorable and depreciate in value.
