The Relevance of Relative Strength

“It’s all in the maps, kid,” he said. The crusty old veteran broker was my mentor during my training at a small office in downtown Manhattan at 44 Broad St., half block from the Exchange. But,I wondered. The maps, as he called them, were stock charts. He liked to look at monthly charts, and I asked him how a depiction of what has already happened could help me figure out what was going  to happen. He told me to keep staring at them and it might come to me.

Staring at the maps has lately been useful. There is a subtle change in leadership that happens during the topping phase of a bull market. Stocks that were favorites during the great rise begin to fade, while stocks that have been out of favor, often for a very long time, begin to outperform the obvious names. This market top is no exception. Many of the big names of the 80s and 90s have stalled. For example:

Microsoft

Five years after the top of the bull market in 2000, MSFT was still the most widely held stock in individual portfolios, but it’s been a net loser for over a decade.

Wal-Mart

Wal-Mart was another favorite, especially among managers of growth funds. No one seems to doubt that the company is a premier holding, but ten years of not making any money must surely be wearing to investors.

“Compare and contrast,” my English Lit teacher would say. So, look at these next four charts and note the difference:

Cummins

Danaher

Gardner Denver

Regal Beloit

These four stocks built long bases during the 80s-90s and emerged during the first decade of this century into powerful bull moves, just as the old favorites and the market as a whole went to sleep. They score high in terms of the Relative Strength Index, a tool market analysts use to rate the potential of a stock or group of stocks. The higher the RSI, the more potential the stocks have.

The importance of this observation is that after the present bear market bottoms, these companies may very well be the leaders of the next bull market.

I don’t see them as buys now. They will come down along with everything else during the hard down phase-just look what happened to them between ’07 and ’09. But, unlike the old faves, these have beaten the overall market and gone on to make new highs. Bodes well for them to come out strong next time the market is a buy.

Observations

The cool thing about this is that none of these companies are being touted as hot stocks. They’re just plugging along on their own. All four are Midwestern manufactures, located deep in the rust belt, a region that has been presumed dead for decades. The maps are saying otherwise. Who’d a thunk? This is the kind of under-the-radar situation that can make an investor serious money when the time is right.

They’ll be worth a closer look in three or four years.

Cheers,

Rod

The author makes no representation as to the accuracy of the quoted material, but believes the sources to be reliable. No one should consider any part of this presentation as a recommendation to buy or sell any securities whatsoever.

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