If you were asked at the beginning of the NFL season to pick a team that would make it to the playoffs, what is the first piece of information you would look at? When trying to predict future results, it is always best to begin by looking at past trends. All else being equal, we generally expect athletes and teams that have historically and recently performed well to continue doing so. This is called relative strength.
Relative strength is not anything new or groundbreaking but analyzing how it works in sports can help illustrate how it works in our investments. Take Tom Brady, for instance. Say what you will about him, but there is no denying the impressiveness of his career achievements with New England and then for Tampa Bay. Except for his rookie season, Brady’s team never finished the regular season with a losing record. In 19 out of his 22 seasons (86% of the time) his team reached the playoffs. In two of those three seasons in which his team failed to advance, Brady played only one game.
Put another way, if you had bet on Brady’s team to make the playoffs at the beginning of any season he was active, you would have been wrong less than 15% of the time. Of the 19 times Brady-led teams made the playoffs, they advanced to the conference championship 14 times (74%), advanced to the Super Bowl 10 times (71%), and won seven championship rings. At any given point, betting on continued strength from Brady’s team was a pretty good wager. This principle is similar to that which underlies relative strength rankings.
Identifying Relative Strength
Every day that the market is open is essentially a giant competition between thousands of stocks and funds. Unlike sports teams that compete against each other one at a time, however, each security in the market is simultaneously competing against every other security. This provides us with approximately 250 head-to-head competitions each year which can be used to evaluate and rank these assets.
Each day, we record the score (i.e., price) for each security. Then we compare the relative performance of each security by plotting the results on a relative strength chart. Over the course of many “games,” a picture begins to develop, indicating which players (i.e., securities) are consistently outperforming the field — these are the players exhibiting positive relative strength. Just as with sports teams, we expect securities with positive relative strength to continue to outperform, until we begin to see evidence that a change in trend is underway.
What Does Relative Strength Tell Us?
Brady was the second-string quarterback during his first two years of college at the University of Michigan and was drafted 199th overall in 2000. This pedigree is less impressive than some of his contemporaries, like Peyton Manning who was a starter most of his college career and was drafted first overall in 1998. And while Manning is undoubtedly one of best quarterbacks in history, Brady won 11 of their 17 head-to-head matchups and made 10 Super Bowl appearances versus Manning’s four.
In the final years of Brady’s career, when fans and the media questioned whether he was too old to play, oddsmakers continued to favor him. Sure enough, at 43 years old he became the oldest player to win a Super Bowl. The excerpt below is from Yahoo! Sports:
Since 2004, Brady’s teams entered the season as Super Bowl favorites ten times in 18 seasons. They were second on the leaderboard three other times. Brady’s Buccaneers entered the 2021 season with the second best odds to win the Super Bowl, behind only the Chiefs.
Below were Brady’s team’s odds entering each of his seven Super Bowl winning seasons:
- 2020 Tampa Bay Buccaneers (10-to-1)
- 2018 New England Patriots (6-to-1)
- 2016 New England Patriots (6-to-1)
- 2014 New England Patriots (13-to-2)
- 2004 New England Patriots (6-to-1)
- 2003 New England Patriots (15-to-1)
- 2001 New England Patriots (60-to-1)
Brady had nearly two decades of dominance and continued this dominance into his mid-40s. NFL fans and NFL bettors will likely never again see anything like this stretch of dominance.
In the NFL, there are no guarantees that a team will post a winning record, advance to the playoffs, or win the Super Bowl. But Tom Brady has shown for the past 20 years that betting on proven strength can tip the odds in your favor.
Similarly, there is no guarantee that relative strength-based investment strategies will continuously provide superior results. However, like selecting players and teams with strong track records, we believe that selecting investments with positive relative strength will allow us to outperform the field over the long term.
Keep in mind that individuals cannot invest directly in any index, and index performance does not include transaction costs or other fees, which will affect actual investment performance. Individual investor’s results will vary. Past performance does not guarantee future results.
The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. Any opinions are those of the author and not necessarily those of Raymond James. Expressions of opinion are as of this date and are subject to change without notice. There is no guarantee that these statements, opinions, or forecasts provided herein will prove to be correct. Investing involves risk and you may incur a profit or loss regardless of strategy selected.
Nasdaq Dorsey Wright is not affiliated with nor endorsed or sponsored by Raymond James.
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. Past performance is not a guarantee of future results.
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.
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