Pairs for Performance

Professional investors watch the two largest sectors of the Australian share market very closely. Financial and Materials (largely miners) make up around two thirds of the value of all companies in the Australia 200 Index. The big picture view is showing unusual performance differences for these key sectors, with important implications for investors, and potential opportunities for traders.

Here’s the sector view:

Australia 200 –Financials vs Materials – Daily

Source: Bloomberg

The red line is the Materials index, the blue, Financials. At the bottom of the chart is the difference in value between the two indices. While they do not move in lock-step, since March this year the change in the relative performance of these two sectors is remarkable.

In the past eighteen months, the Materials index fell from a high above 15,000 to below 9,000 (down 40.3%). Over the past twelve months, the Financials index rose from below 3,600 to levels above 4,700 (up 31%). By value, Financials now make up 42% of the Australia 200, and Materials 21%. Just six months ago, both sectors were around 30%

Fundamental factors played an important role in this enormous shift in relative value. Miners were hit by lower commodity prices stemming from fears of a collapse in global demand (read hard landing in China). Compelling dividend yields and receding threats to the global banking system from Europe drove banks higher. It’s my view that the market action is overdone in both cases.

Investor Alert

Fund managers with billions of dollars in the market stay closely tuned to these shifts. Regardless of the fundamentals, these price changes can spark action – selling Financials and buying Materials. This locks in gains on outperforming banks, and rebalances a portfolio back towards miners that may be in “value” territory.

Individual investors seeking superior returns could consider the same strategy, in anticipation that more fund managers will take the same course over the next weeks and months.

Trading Opportunities

Traders who agree with this outlook are presented with a wealth of potential trades. Some relative value trading strategies, or pairs trades, are outlined in this previous post: http://blog.cmcmarkets.com.au/2012/04/12/pairs-trading-an-explanation/

The right pair or basket is up to the individual trader, depending on current positions and individual stock opinions.  Keeping it simple, a pair in the two heavyweight stocks in each sector is possible.

CBA is favoured as a short as it will not pay a regular dividend until February (ANZ, CBA and NAB will go ex-dividend in November). BHP’s diversified, global commodity portfolio make it a candidate for a long position. Here’s the chart:

CBA (Blue) vs BHP (Pink) Daily

Source: CMC Tracker

Some traders could take uneven value positions (long BHP, short CBA), depending on their view. A neutral value trade, at yesterday’s closing prices, could look like this:

Buy 30,000 BHP (approx. $1,000,000 divided by last price $33.45)

and simultaneously

Sell 17,500 CBA (approx. $1,000,000 divided by last price $56.99)

About michaelmccarthycmc

Chief Market Strategist - CMC Markets and Stockbroking Regular on ABC, BBC, Bloomberg, Channel TEN, CNBC, SBS and SKY
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2 Responses to Pairs for Performance

  1. Vlad says:

    Thank you, Michael, for pointing out. This is a spectacular divergence. Standard and Poor’s may want to rebalance the Aussie 200 to it’s “normal” configuration, but I guess they just can not throw away any of the Big 4, may be they can start from BOQ…

    I am wondering what holding time you would envisage for such a pair. It looks like if we opened those positions at any time earlier, even as far back as in July or June, when this divergence was already quite clear, by now the gains would be still about 0 or negative. At the same time, financing of the long position at RBA + 2% or + 2.5% and income from the short position at RBA – 2% or – 2.5% would cost us $50,000 per year or about $4,500 per month, in addition to ~$4,000 brokerage.

    • Fair point Vlad. My trade in CBA/BHP is a short term view – would expect to be trading out in a matter of weeks. However, from an investment point of view (switching from “yield” or “defensive” plays into “growth”) I think this is a theme that will be relevant for months.

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