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Trading in financial markets involves significant risk of loss which can exceed deposits and may not be suitable for all investors.
Before trading, please ensure that you fully understand the risks involved
Trading in financial markets involves significant risk of loss which can exceed deposits and may not be suitable for all investors. Before trading, please ensure that you fully understand the risks involved

Monday, July 06, 2020

Big Tech & Mobile Payments - The way Forward

By Century Financial in Investment Insights

Big Tech & Mobile Payments - The way Forward
Big Tech and Mobile Payments - the way forward!

Risks & Assumptions

The strategy might suffer from look-ahead bias which occurs due to use of information or data in a study or simulation that would not have been known or available during the period being analyzed. This can lead to inaccurate results in the study or simulation.
Future price movements may not be exactly the same as the historical price movements and this could lead to variation in performance.
Testing can sometimes lead to over-optimization. This is a condition where performance results are tuned so high to the past they are no longer as accurate in the future.
The model assumes no slippages in trading. Slippage refers to the difference between the expected price of a trade and the price at which the trade is actually executed.
Drawdowns in actual trading can be higher than the tested system and loses could significant in the event of leverage.
Unforeseen events can lead to variation in performance from the tested trading strategy.
The tested result has been computed with price feeds available from Bloomberg.
The testing environment has not considered transaction or any other costs.
Trading indicators used for the purpose of testing has been provided by Bloomberg.
The strategy might suffer from data mining fallacy, selection bias and bakfill bias.

US Stocks were at record highs at the start of the year, only to be sent reeling as Covid-19 cases started rising dramatically across the world. However, markets bounced back in April, driven by fiscal stimulus from the Fed, and plans to open their economies. As investors approach the second half of the year with a resurgence in coronavirus cases and hopes of a cure, it’s tough to determine if the recent recovery will be short-lived or an indication of a rally later in the year. In the current perplexing environment, pair trading strategy can allow investors to participate in the market and keep a check on the losses.

| What is Pair Trading?

A market-neutral strategy which involves simultaneously matching a long position with a short position in two different securities that are correlated. The two offsetting positions form the basis for a hedging strategy that seeks to benefit from virtually any market conditions: uptrend, downtrend, or sideways movement. However, it is important to note that Trading pairs is not a risk-free strategy. The difficulty comes when prices of the two securities move contrary to the positions taken resulting in losses. Thus, it is important to adhere to strict risk management rules when dealing with such adverse situations.

| Strategy

The returns in the table below have been derived by undertaking long positions on Big Tech and Mobile Payment while simultaneously shorting the SPX Mid Cap index. The exposure taken on the long side was equivalent to exposure on the short side. For instance: if $500K worth SPX Mid Cap was sold, then simultaneously $250K worth Big tech and $250K worth mobile payment were bought.

| Back-tested data based on the current index constituent weights

Mobile Payment Return
Big Tech Return
Average Return (Big Tech & Mobile Payment)
SPX Mid cap Return
Long: (Big Tech & Mobile Payment) Short: SPX mid cap (2x leverage)
YTD (6/30/2020)
12% 13% 12% -9% 21%
43% 50% 47% -4% 51%
21% 2% 12% 13% -1.1%
50% 42% 46% 16% 30%
10% 36% 23% 13% 10%
20% 9% 15% 0% 15%
7% 22% 15% 10% 4%
46% 50% 48% 26% 22%
Total 152%
Average 20%

The strategy has been back-tested on the current constituent weights and hence the results are subject to backfill bias and selection bias.

Besides, Data for Stocks like Paypal (current weight-10.4%), i3 Verticals Inc (2%), square (2.18%), Evo Payments Inc (1.9%), was not available since the start as they were not listed in 2013. For example, Paypal was listed in the year 2015. In such instances, for the days prior to listing, the weightage of Paypal has been distributed among the other stocks on the basis of their individual weights.

| Strategy Rationale

While many areas of the economy are currently losing a vast majority of their revenue such as travel and hospitality, logistics, offline entertainment or live events, the tech has remained resilient in a pandemic as cloud services and digital stores thrived in a stay-at-home economy. Observers would have noted that tech companies were some of the first companies to move their workforce to work-at-home very early in the epidemic. This lower dependence on physical presence and the substantial cash balances at their disposal makes many tech stocks significantly more resilient to the current downturn. This crisis has proven that tech is indispensable, and it should only speed up the transition to more tech: video meetings, telehealth, cloud computing etc. With tech deeply embedded into daily life, there’s good reason to believe that the sector will keep up better than the rest.

Another trend that has gained traction is the adoption of the digital payment solution. As governments took resort to lockdowns to curtail the spread of COVID-19, human life took a radical digital shift for almost anything and everything they want. Streaming, Online shopping, online payment activities found every reason to surge in this trying time as these activities conform to social distancing has less to do with human contact. While digital payment is almost commonplace in developed countries, emerging markets are still lagging to a large extent when it comes to paying online. But coronavirus-led lockdowns have now forced many to opt for online operation and will help change the trend in emerging nations. As per Statista estimate, digital payment transactions will surge by 15% YoY in 2020 with a +5% uptick in users.

Going forward, even as many countries open their economies, remote working and social distancing measures would have to remain in place at least until a vaccine is available, and this trend should continue to add to the top line of tech and digital payment companies while hampering the growth of small-mid size companies related to the retail, travel, hospitality sector etc. Although, in an unpleasant way, the deadly virus has practically served as an advertisement for the need and the benefits of having a digital presence. The icing on the cake is that new users who have stepped into a digital world, are unlikely to abandon the technology when the pandemic is over.

The world is in the early innings of the latest leg of the industrial revolution called digital transformation. The companies leading this transformation should emerge from the current market turbulence in much better shape than the general market.

Data Source: Bloomberg

Arun Leslie John
Chief Market Analyst

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