Thus far, 2024 has been positive for US equities, with the S&P 500 ([SPX]) up roughly 5% year-to-date (through 2/14), however, concerns about an uptick in inflation and what that means for the direction of monetary policy have recently reemerge. Even if the market were to reverse course and finish the year in the red, there will almost certainly be areas of strength, as we typically see wide dispersion between the best-performing and worst performing sectors based on market fluctuations. Throughout our study, from 1993 through 2023, the S&P 500 posted a negative calendar year return six times, but there were only two years – 2002 & 2008 – in which all of the Dow Jones sector indices finished the year in the red. In 2022, when the S&P was down nearly 20%, the Dow Jones US Oil & Gas Index ([.DJUSET]) was up more than 60%.

The Sector vs. Market Timing study can be a useful tool both for coaching clients to stay the course in a turbulent market, like the one we found ourselves in 2022 and for explaining intra-market dispersion and the value of relative strength strategies generally.

Dispersion refers to the performance difference between the best and worst-performing assets and quantifies the opportunity available to tactical strategies. Relative strength-based strategies tend to offer excess return over their benchmarks more readily when the dispersion between the best and worst performers is very wide. The reason for this is straightforward - the more divergence that exists between the best and worst performers, the more potential value can be added by owning good-performing assets and avoiding the bad performers. When there is more dispersion, there is more potential for a tactical decision to produce a meaningful result. On the other hand, such strategies will tend to suffer or at least become muted when the dispersion is narrow. Taken to an extreme, if all investment possibilities were up the same amount each month and each year, tactical management would have no opportunity to add value via rotation. From 1993 through 2022, the calendar year dispersion between the best- and worst-performing broad DJ sector indices have ranged from a low of just over 25% in 2012 to a high of nearly 97% in 1999 and 2022, with an average of just over 45.5% In most years the sector dispersion has been greater than the total return of the S&P 500, meaning that there was potentially more to be gained from sector allocation than from deciding between the S&P and cash, as our study further illustrates.

Our study tracks the return of four hypothetical investors over 30 years, from 1993 through 2023, the first investor who we’ll dub, “Mr. Buy and Hold” simply buys the S&P 500 Index and rides it up and down, making no movements at all in the portfolio. “Mr. Perfect Market Timer”, our second investor, is assumed to be clairvoyant and is

only invested during months in which the S&P 500 Index is up. In 2008, for example, this investor would have only been invested in April, May, August, and December, as those were the only positive months that year. In our view, this is about as “perfect” as any “market timer” could ever hope to be, and thus we feel this quantifies well as the best-case scenario for market timing.

Our last two investors are both sector investors, one of whom, “Ms. Perfect Sector”, knows each and every year what the best-performing sector will be for that year, and invests 100% of her portfolio in just that one sector. The fourth investor, “Mr. Worst Sector”, is an unfortunate fellow, who perhaps just follows a favorite magazine cover and is on the wrong side of things every year. He manages to invest only in the single worst-performing sector.

As you might imagine, each of the investors has seen dramatically different results over the years from their initial investments of $10,000 back in 1993. At the end of 2023, Mr. Buy and Hold had a portfolio value of about $200,000 while Mr. Perfect Market Timer had a portfolio value of nearly $28 million. Ms. Perfect Sector saw her portfolio swell to $93 million, all while poor Mr. Worst Sector’s portfolio was worth only $268! Yes, you read that right - $268 from the starting point of $10,000.

Disclaimer:

Nasdaq Dorsey Wright is a registered Investment advisory firm. Registration does not reflect any certain level of skill or training.

Past performance does not guarantee future results. In all securities trading, there is a potential for loss as well as profit. It should not be assumed that recommendations made in the future will be profitable or will equal the performance as shown. Investors should have long-term financial objectives when working with Dorsey Wright. The relative strength strategy is NOT a guarantee. There can be times where all investments, asset classes, and strategies are unfavorable and depreciate in value. Relative Strength is a measure of price momentum based on historical price activity. Relative Strength is not predictive and there is no assurance that forecasts based on relative strength can be relied upon.

The information contained herein has been prepared without regard to any particular investor’s investment objectives, financial situation, and needs. Accordingly, investors should not act on any recommendation (express or implied) or information in this material without obtaining specific advice from their financial advisors and should not rely on information herein as the primary basis for their investment decisions. Information contained herein is based on data obtained from recognized statistical services, issuer reports or communications, or other sources believed to be reliable (“information providers”). However, such information has not been verified by DWA or the information provider and DWA and the information providers make no representations or warranties or take any responsibility as to the accuracy or completeness of any recommendation or information contained herein. DWA and the information provider accept no liability to the recipient whatsoever whether in contract, in tort, for negligence, or otherwise for any direct, indirect, consequential, or special loss of any kind arising out of the use of this document or its contents or of the recipient relying on any such recommendation or information (except insofar as any statutory liability cannot be excluded). Any statements nonfactual in nature constitute only current opinions, which are subject to change without notice. Neither the information nor any opinion expressed shall constitute an offer to sell or a solicitation or an offer to buy any securities, commodities or exchange traded products. This document does not purport to be complete description of the securities or commodities, markets or developments to which reference is made. Advice from a financial professional is strongly advised.

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