The January market turmoil, in my opinion, is a
rehearsal for much bigger action that is going to settle current market divergences. Let’s
take a look at volatility-adjusted pairs in the stocks/high-yield/treasuries
triangle.
Stocks (SPY) vs. high-yield bonds (HYG):
10-years treasuries (IEF) vs. stocks (SPY):
10-years treasuries (IEF) vs. high-yield bonds (IEF):
This charts show that high-risk assets, such as stocks
and high-yield bonds, are heavily overbought comparing long-term treasuries,
which are not cheap by itself, thanx Ben. Current risk-on period, starting
middle of 2012, results in market tilt toward risk assets. The situation is pretty
much equal to 2007.
Expectation of rising rates is common today, and
public is rather expecting the downtrend in treasuries, but January surge of
fear demonstrated how easily money run from risk assets into treasuries in
first glimpse of troubles.
I think we should not forget that there is a Big
Chinese Problem ahead, and if this problem will start to unfold, the panic will
result in much more significant capital reallocations.
So, the whole picture gives us several ideas for volatility-adjusted pair trading with an expected horizon about a year:
1. Short stocks against long treasuries. Most convenient
trade, because we have super-liquid futures for both stocks (ES futures) and 10-year
treasuries (ZN futures) with very modest margin requirements.
2. Short high-yield bonds against long treasuries. Since
high-yield is overbought even comparing to stocks, this market tilt has bigger
potential, but implementation of this trade can be more complicated. We have to
go short with high-yield ETFs like IEF/TLT with margin requirements about 1:4
and short position fees or we can go long with inverse ETF SJB with low
liquidity and even bigger margin requirements.
3. For those who is afraid go long treasuries, the
trade long stocks short high-yield can be played. The bonus is, as you can see
on the first chart, this kind of trade should work out fast.
This research is performed using Cognitum Rebalancer.
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