How We Invest
Relative Strength is the cornerstone of our investment process.
"Relative Strength" speaks to the “strength” of one security “relative” to another. If security A advances by more than security B then it’s showing positive Relative Strength. If security A declines, but by less than security B, it’s still showing positive Relative Strength.
For example, both the financial and Energy sectors outperformed the S&P 500 in 2016 and would have made for better investment choices providing superior returns.
It’s important to understand that we use Relative Strength to reduce risk of loss as well as increase our upside potential. Weak sectors lag in rising markets and tend to lose more in falling markets. Weak sectors, once identified should be avoided or considered for short positions.
As Charles Dow (the 1st Editor and Chief of the Wall Street Journal) once said “Sell your losers early and let the winners run”.
Successful investors know that in order to succeed, they must clearly see what is really happening in any market. To do that, you need a process that allows you to see what other investors can’t - that’s your edge. Successful investors know to track the “smart money”. It is institutional money (with hundreds of millions of dollars to invest) that are responsible for changes in the market. It is institutional money that drives supply or demand for a security and therefore price.
We all understand the basic forces of supply and demand. As demand for a product or service increase, so too does its price. Conversely, more supply for particular goods than interested buyers result in falling prices. The same laws of supply and demand are what ultimately drive prices of any market, sector or security. Once understood, successful investing becomes a matter of finding a strategy that exploits this relationship and that’s where RWM shines the brightest.
We use a proprietary investment process based on complex algorithms to breakdown markets into supply and demand relationships that allows us to clearly see where institutions are investing and where their not.
Its all about finding that price trend and riding it until our research and indicators tell us otherwise.
Consider this example. Between February of 2016 and January of 2017, the S&P 500 index gained over 22%. Not bad right? Well, while most individual investors were buying into what the financial media was selling - the S&P 500 Index, our indicators were monitoring the big Wall St. institutions, as they put millions to work into two sectors - “Steel” and “Metals and Mining”. The buying frenzy caused those groups to crank out gains in excess of 140% and 125%, respectively. That’s more than 6 times what the “average investor” earned by following the crowd.
We take a top down approach. Meaning we first analyzing each markets strength against every other market - using algorithms to mathematically rank each market against the other. This guides the investment process as we can quickly see which of the six markets is strongest and deserves investment capital and which markets are the weakest and should be avoided.
The next step in our process is to drill down deeper into each market and determine the strongest sector within each market. The graphic below compares absolute performance of different industry groups (sector) within the U.S. Equity market vs. the S&P500 Index.
The sector quilt above provides sector and market performance (S&P500) dating back to December 2006 thru January 2017. The navy blue box represents the performance of the S&P, while each sector is represented by miscellaneous colors. As you can clearly see, the navy blue box, representing the S&P 500 Index usually resides in the middle of the pack.
The reason for this is because the S&P500 is compromised of all 10 sectors making up the U.S. equity market - therefore the S&P 500 is considered an “average” (although unequal) and it’s returns generally reflect that. The old adage that a rising tide lifts all boats isn’t universal. Take 2007 for example; while Energy and Basic materials earned 35.34% and 19.79%, respectively, the Healthcare and Financial sectors lost more than 20%, as the S&P 500 barley kept afloat earning 3.53%.
According to a study provided by our friends at Dorsey Wright & Associates, the average differential between the best performing sector and the worst is a staggering 43.65%...
Consider that in a multiple of years and you can imagine the impact choosing the best sectors can have on your future wealth.
Relative strength can be applied to mutual funds as well. Above is a back tested model in which the universe of American funds Mutual funds would be compared to one another on a monthly basis, at the beginning of each month the 5 strongest funds on a relative basis comprised the portfolio. The blue line represents the performance of the American Funds 5 model, the green line represents a typical asset allocation model (70% Equity-30% Fixed), while the blue line represents the S&P 500 total return. You can see a significant spread (red arrows) between the American Funds model based on Relative Strength vs. and strategic asset allocation model or the S&P 500 total return.
Still not convinced. Below is a simple study illustrating the impact on a $100,000 investment made to the strongest asset class, the two top asset classes, owning all six major asset classes and the results of being unlucky enough to own the weakest assets class. The results are impressive.