Earlier this quarter we updated our white paper on using relative strength to invest in stocks. If you haven’t read the paper you can find it here. In this post I will be recapping the performance of various relative strength (momentum) factors using the same methodology used in the paper.
The S&P 500 had a great first quarter ending up about 12% (price only). Relative strength strategies did OK. The best performing factors during Q1 were actually the factors that performed the worst over a long time horizon (see the white paper for details). Several of the best long-term winning factors had a tough time in Q1.
(Click To Enlarge)
The graph above shows the returns for all 100 trials for each of the time-based RS factors we track. A trailing 18 month and 36 month window to compute RS worked very well. These worked well because those models didn’t rotate into low volatility names at the end of last year, and then rotate back out of them during Q1. In effect, the long time horizon allowed them to capitalize on the laggard bounce that was so prevalent during the first part of the quarter. The very short-term windows also did well. They were able to quickly rotate into the high beta names that were the leadership. But, more importantly, that trend was sustainable so the short-term mean reversion effect didn’t hurt those factors in Q1. The 6 month and 9 month factors performed very poorly. The main reason is these intermediate term factors rotated into low beta and high dividend stocks at the end of last year. Those were the laggards during Q1, and it took some time for those models to rotate into the new leadership. Keep in mind, however, that these two factors are two of the best performing over long time horizons.
The laggard bounce was most pronounced in January and February. By March things had settled back down and the intermediate term factors were performing well. The better performance was the result of the market rewarding intermediate term momentum, and the models having a chance to shed the laggards and re-position themselves into the current leadership.
January Performance
(Click To Enlarge)
February Performance
(Click To Enlarge)
March Performance
(Click To Enlarge)
The turnaround for intermediate term momentum strategies wasn’t enough to totally reverse the underperformance during the first two months of the year. But it is very good to see the intermediate term factors getting back into gear! We noticed the same thing in our managed portfolios too. Things definitely picked up in the last part of the quarter for high RS stocks.
All of the factors in this post are simple, time based relative strength (momentum) factors. These are the factors that match what we published in the white paper. We do track other RS factors though. It is interesting to note, that the underperformance of the intermediate term factors was most pronounced in the simple, time based factors. Intermediate term factors we track that use some sort of smoothing or multiple time periods performed much better than the 6 and 9 month factors. The only explanation I have for that is that the 6 month ranking window was the perfect time to maximize your whipsaw into low volatility and back out again. The smoothed and compound factors did a much better job this quarter at avoiding that whipsaw.
