USING RELATIVE STRENGTH as a way to analyze stocks is a favourite way for investors to beat the market. In particular, if your clients invest in a sector or stock that is rising faster than the broader market, then they have a built-in advantage.
Of the 28 sector and industry group subindices within the S&P/TSX composite index , 13 have rising relative strength at this point in the market cycle. Another seven industry subindices show dropping relative strength, meaning they are underperforming vs the market. And the remaining eight subindices are in doubtful or indeterminate trends.
Because relative strength trends tend to last for two years or more – sometimes, even for decades – these differences are worth considering when planning portfolio strategy for your clients.
The advantage of focusing on sectors with strong relative strength improves when you combine it with fundamental analysis. Using relative strength trends can keep your clients out of sectors that look good but are losing their way in the market.
The basic method of measuring relative strength is to compute the price of a stock or index relative to a broad market index. Over time, a trend is likely to become obvious.
Software and services has the longest current rising trend in relative strength, at six years. Transportation has been rising for almost five years. This is a few months longer than the rising trends for oil and gas storage and transportation (pipelines), pharmaceuticals and biologicals, diversified financials and healthcare equipment and services.
If you consider secular trends in relative strength, taking in short periods of reversal, transportation holds the current record. It has outperformed the market since 2000.
Completing the list of sectors displaying a rising trend (with their trend durations in months to the end of August 2012) are: oil and gas drilling (41 months), real estate (39), consumer services (35), food beverages and tobacco (28), telecommunication services (18, within a 35-month secular trend), retailing (27), and food and staples retailing (17, within a four years-plus secular trend).
The record holder in fading relative strength is the forestry and paper sector. It has dropped relative to the market ever since the Toronto Stock Exchange first started indexing the sector in 1960, with occasional one-year or two-year rallies. But note this sector’s recent rally.
Running next-longest on the “down” track is media, which has been in a secular drop since 1999.
Sectors in which the trend of relative strength is uncertain are worth watching for upward swings. Paper and forestry, for example, has rallied sharply for a year. Relative-strength trends of banks, utilities and consumer durables/apparel are running sideways. And the long rate of descent in the relative strength of the commercial and professional services subindex may have flattened.
Capital goods’ rise in relative strength may have broken dow1n6 since 2006. So, perhaps, has oil and gas equipment and service1s.2 Finally, gold’s immediate trend is in doubt, although it started on a secular uptrend 12 years ago. 8
Of the industries clearly losing altitude in relative strength (in addition to media), three are4 resources industries – oil and gas exploration and production, 0 integrated oils, and metals and mining. Technology hardware and equipment, the hero of the 1990s high-tech boom, has sunk to a new low in relative strength. Insurance has underperformed for eight years. The automobile subindex has dropped in relative strength for 20 months.20
Stocks in industries locked into long-term relative perfor1m5ance weakness do bear analysis to see if there is an exception. A notable example of long-term underperformance is the U. S. airlines industry from 1989 to 2009. During this time, thoug5h, shares of Southwest Airlines Co. have gained in price and rela0 tive strength. It had been a stock worth owning until 2000-02, partly because its dividend had increased four times.
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