What does the strategy do?
There has been much debate about whether it is better to buy weak stocks or strong stocks. The theory behind buying weak stocks is that you have the opportunity to “buy low and (hopefully) sell high.” The theory behind buying strong stocks is one of momentum – an object in motion is most likely to continue in that motion. This is also true with industry groups – however, not to the same degree. While a given company may go out of business for any number of reasons, it is a much more rare occurrence for an entire industry group to decline in price and never rebound.
Generally speaking, there is a pattern which is not uncommon for industry group price performance. At some point, the fundamentals for a given industry go south and eventually so do the stocks in that industry group. This can go on for any period of time, but usually does not last much longer than about two years. Once the majority of the decline is over, the group may then experience a period of basing action for up to a year (actually, the longer the better). Once this long decline and basing period is over, it is not uncommon for a group to then reemerge as a leading performer.
So which is better? Buying “weak” industry groups or “strong” industry groups? Jay Kaeppel’s research has led him to the Best of Times, Worst of Times that utilizes both strategies rather than attempting to choose one or the other.