Relative Strength Newsletter - 3rd Quarter 2021
Relative Strength Recap
The sideways, rotational market that began in Q2 continued throughout Q3. The persistent tug-of-war between Growth (Technology) and Value (Financials, Industrials) is still ongoing and closely tied to interest rates. The quarter began with anxious investors debating the risks of the Delta variant and inflation. However the Olympics, at least for a brief moment, provided a respite from the never-ending gloom and doom. There was a real sense of pride for us here in Beaufort as one of our own, CJ Cummings, a Beaufort High graduate and the youngest member of USA weightlifting had a shot at a medal. CJ came up short but made his hometown proud.
Corporate earnings exceeded expectations and, while input costs are rising, companies have been able to pass those costs on to customers. Despite those higher input costs, we continue to see margin expansion as sales growth is expanding faster than the rise in raw materials and labor costs. Corporate and Consumer balance sheets are flush with cash due to the unprecedented fiscal and monetary stimulus creating strong demand. Asian lockdowns, shipping issues and rail/trucking bottlenecks have created inflationary fears as supply has been unable to keep up with demand. However, the Fed’s “transitory” inflation expectations are predicated on many of the supply chain issues moderating as the Delta variant wanes. As we write this update, those issues have not abated and are likely to persist into Q4. We expect this “tug-of-war” environment to continue as investors weigh the pros (GDP growth, fiscal and monetary stimulus, earnings growth and a healthy U.S. consumer) and the cons (Chinese regulatory crackdown/debt issues, rising inflation, taxes and interest rates). We continue to believe that we are in the midst of a young bull market. Overall, Bull markets tend to last ~5 years with average returns of 155% vs our current Bull market which has returned just under 100% over less than 2 years. While we continue to see upside, we would be mindful that pullbacks can transpire with the average intra-year pullback during a Bull market of 8%-12%. We would continue to advise adding to portfolios on any market weakness.
In our Relative Strength work we have noticed one significant change. U.S. Equities remain the highest ranked asset class but Commodities, thanks to surge in energy prices, have passed International Equities for the #2 spot.
Thought Process
The book, “What Works on Wall Street: the Classic Guide to the Best-Performing Investment Strategies of All Time,” by James O’Shaugnessy, is an excellent resource for investors. It was originally published in 1997 and the 4th edition is now in print. The book was written, and has since been updated, to illustrate which return factors are robust when tested over a long period of time, and, in the alternative, which fail too frequently to be used with confidence by investors.
Many growth and value factors were tested, along with others including relative strength. The summary of findings within the book establish a useful foundation for how you might construct equity portfolios.
The book highlights several time-tested investment themes and we’d like to cover three of our favorites over the next couple of issues. Theme one ‘The only way to beat the market over the long term is to use sensible investment strategies consistently… The lack of discipline devastates long-term performance’.
The ability to make rules-based investment decisions, and to do so in a repeatable fashion, is easier said than done. It becomes far more challenging when the factors that guide your “rules” are ambiguous to begin with. Many fundamental inputs, whether growth or value oriented, can be ambiguous over time. Accounting standards can shift; analysts can focus upon top-line instead of bottom-line numbers, etc. All of us can recall the manner in which “dot-com” companies had their numbers massaged by analysts in an effort to generate positive opinion as the stocks were rising. When the stocks began to fall, changing that opinion in a timely fashion was hard to do, since the data supporting the “buy” recommendation didn’t change. If an analyst says to “buy” a company that isn’t making the money, the simple observation that they are still not making money a year later doesn’t give cause to downgrade the stock.
Market psychology can change much faster than company fundamentals, and this is why price inputs are so useful. Price is an objective input, and the primary calculation based solely upon price inputs is Relative Strength analysis. There is no “pro-forma” relative strength calculation that might be confused with the Generally Accepted Accounting Principals (GAAP) relative strength analysis. Relative strength is calculated simply by dividing the price of one security by another on a daily basis, and that calculation comes to life once plotted on a chart. At any point in time, said chart can either point to a buy signal or a sell signal. There is no gray area, allowing the practice of constructing relative strength-based portfolios to be conducted in both a “sensible” and “consistent” manner.
Tumlin Levin Sumner Wealth Management of Raymond James
Any opinions are those of TLS Wealth Management of Raymond James and not necessarily those of RJA or Raymond James. The information contained in this report does not purport to be a complete description of the securities, markets, or developments referred to in this material. There is no assurance any of the trends mentioned will continue or forecasts will occur. The information has been obtained from sources considered to be reliable, but Raymond James does not guarantee that the foregoing material is accurate or complete. Any information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation. Investing involves risk and you may incur a profit or loss regardless of strategy selected. The Dow Jones Industrial Average (DJIA), commonly known as “The Dow” is an index representing 30 stock of companies maintained and reviewed by the editors of the Wall Street Journal. The S&P 500 is an unmanaged index of 500 widely held stocks that is generally considered representative of the U.S. stock market. Some material prepared by Dorsey Wright & Associates (DWA), an independent third party.