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Thursday, July 01, 2021
Germany Tech 30 - Spain 35 Consequences of a Hawkish Tilt
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*This performance is only observed with historical backtests and not traded by the company
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The yield curve started to flatten in the second quarter of 2014 and resulted in the outperformance of Tech sector, along defensive stocks such as utilities and healthcare. Sectors such as financials, energy and industrials performed poorly. US Federal Reserve Chairman Jerome Powell’s hawkish tilt on transitionary inflation has led to the flattening of the yield curve Along with US treasury spreads narrowing, the Germany Bund (benchmark for European yields) spreads also narrowed during the same period.
A Multi-Month Trend
The latest economic forecasts released by the Fed in the FOMC meeting for the month of June 2021, 11 of 18 policymakers expected at least two interest rate hikes by the end of 2023. The prospect of those earlier-than-expected moves have soared short-term yields higher while keeping longer-duration yields subdued as market fears of out-of-control inflation subside.
Presently, the economy is expected to witness a similar wave like it did in 2014 and thus the tech dominated indices in the EU zone should fundamentally outperform the indices that are dominated by the financial sector. This could be a gradual and a multi-month trend.
In 2014, as the yield curve started to tumble, the Germany Tech 30 Index rallied and outperformed the Spain 35. The ratio between the two indices increased from 0.1121 to 0.2083, roughly 85% rise as portrayed in the chart below.
The Pair Trading Strategy involves going long on Germany Tech 30 increasing in value and simultaneously holding a short po- sition on Spain 35.
Almost half of the Germany Tech Index is dominated by the IT sector which is expected to surge the most. The technology-based companies are anticipated to benefit from lower long term interest rates implying a higher present value of future cash flows. A higher chunk of the index is composed of companies from the healthcare sector which is defensive by nature and are dividend paying companies.Whereas the Spain 35 is formulated of the financial sector, succeeded by the Industrial and Communication sector. The banking sector will logically witness reduced net interest margins due to narrowing yield spreads in a flattening yield curve scenario. Additionally, the Industrial sector may foresee lower profit margins since a cap on inflation implies a cap on sales price.
Macro View on Holdings of Germany Tech 30 & Spain 35
Germany Tech 30 Sector Constituents
|Sector||€ Market Cap (In Bln)||Market Cap %|
Date: 23rd June 2021
Spain 35 Sector Constituents
|Sector||€ Market Cap (In Bln)||Market Cap %|
Date: 23rd June 2021
However, it is important to note that Trading pairs is not a risk-free strategy. The jeopardy 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.
Disclaimer: Individual stocks in the index are subject to both weightage recalculation & recomposition risk. As a result, certain stocks may be added or removed from the index upon index recalculation. Consequently, the performance of the relative index may deviate from the one specified above.
Note: Trading Timings (subject to change) -
Germany Tech 11.00-19.30 GMT+4
Spain 35 10.00-22.00 GMT+4
Risks and Assumptions for Back-tested trading strategies
Data Source: Bloomberg
Arun Leslie John
Chief Market Analyst
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