Relative Strength, Decade by Decade

June 5, 2012

This post explores relative strength success by decade, dating back to the 1930s.  Once again, we’ve used the Ken French data library and CRSP database data.  You can click here  for a more complete explanation of this data.

Chart 1: Percent Outperformance by Decade.  This chart shows the number of years in which relative strength has outperformed the CRSP universe each decade.  RS outperformance has occurred in at least half of all years each decade.

Chart 2: Average 1-Year Performance by Decade.  This chart shows the average yearly growth by decade of a relative strength portfolio and of the CRSP universe.  Each decade, the average performance of relative strength has been greater than the average performance of the CRSP universe.  Generally speaking, when the market’s average performance is increasing, RS outperforms CRSP by a greater percentage than it does when the market is doing poorly.

In short, relative strength has been a durable return factor for a very long time.

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Relative Strength vs. Value – Performance Over Time

May 31, 2012

Thanks to the large amount of stock data available nowadays, we are able to compare the success of different strategies over very long time periods. The table below shows the performance of two investment strategies, relative strength (RS) and value, in relation to the performance of the market as a whole (CRSP) as well as to one another. It is organized in rolling return periods, showing the annualized average return for periods ranging from 1-10 years, using data all the way back to 1927.

The relative strength and value data came from the Ken French data library. The relative strength index is constructed monthly; it includes the top one-third of the universe in terms of relative strength.  (Ken French uses the standard academic definition of price momentum, which is 12-month trailing return minus the front-month return.)  The value index is constructed annually at the end of June.  This time, the top one-third of stocks are chosen based on book value divided by market cap.  In both cases, the universes were composed of stocks with market capitalizations above the market median.

Lastly, the CRSP database includes the total universe of stocks in the database as well as the risk-free rate, which is essentially the 3-month Treasury bill yield. The CRSP data serves as a benchmark representing the generic market return. It is also worthwhile to know that the S&P 500 and DJIA typically do worse than the CRSP total-market data, which makes CRSP a harder benchmark to beat.


Source:Dorsey Wright Money Management

The data supports our belief that relative strength is an extremely effective strategy. In rolling 10-year periods since 1927, relative strength outperforms the CRSP universe 100% of the time.  Even in 1-year periods it outperforms 78.6% of the time. As can be seen here, relative strength typically does better in longer periods. While it is obviously possible do poorly in an individual year, by continuing to implement a winning strategy time and time again, the more frequent and/or larger successful years outweigh the bad ones.

Even more importantly, relative strength typically outperforms value investment. Relative strength defeats value in over 57% of periods of all sizes, doing the best in 10-year periods with 69.3% of trials outperforming. While relative strength and value investment strategies have historically both generally beat the market, relative strength has been more consistent in doing so.

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Momentum Over Multiple Cycles

November 23, 2011

In a recent interview, Jim O’Shaughnessy made the case for following quantitative strategies that have performed well over multiple market cycles:

The average investor does significantly worse than a simple index … It’s literally because of the way our brains are wired. As [neuro-finance researchers] look at super-fast scans of the brain making decisions under uncertainty, we see that even with a so-called professional investor making the choice, it is not the rational centres of the brain that fire when they’re making those choices. It is the emotional centres of the brain.

That’s one of the reasons why finding good strategies that have performed well over multiple market cycles – and then having the ability to stick with them through thick and thin, even when they’re not working for you – is the key to good long-term success.

Which brings me to the long-term performance of relative strength strategies.  We tracked down total return data for the S&P 500 going back to 1930 and compared it to the momentum series on the website of Ken French at Dartmouth (top half in market cap, top 1/3 in momentum).  The chart below shows 10-year rolling returns, which is why it starts in 1940.  The average ten-year returns?  405% for relative strength and 216% for the S&P 500, a near doubling!  That’s without the momentum series getting any credit for dividends.  Even more impressive, the ten-year rolling return of the relative strength series outperformed in 100% of the time periods.

Click to enlarge

Source:  J.P. Lee, Dorsey, Wright Money Management

Results such as these should provide more than enough confidence to stick with relative strength through the thick and thin.

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