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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

Thursday, February 16, 2023

Pair Trade Analysis- Nasdaq-100 & South Africa-40

By Century Financial in Investment Insights

Pair Trade Analysis- Nasdaq-100 & South...
Pair Trade Analysis-Nasdaq-100 & South Africa-40

*Trading in financial market carries risk and can result in loss of capital.
*This performance is only observed with historical backtests and not traded by the company.


The product and investment ideas do not consider the risk profile and financial position of the recipient and may not be suitable for everyone. Trading in financial markets and use of margin involves a significant risk of loss, which can exceed deposits. Please read the complete disclaimer carefully.


Considering the high volatility of commodity products, suffcient client margin should be maintained in the account.
The holding rate can change, negatively or positively impacting the trade.
The testing environment has not considered transactions or any other costs.
Returns may vary if there is any error in executing the trades.
Past performance is not indicative of and does not guarantee future results. Trading in markets may involve a loss of capital. Please read the complete disclaimer carefully.
A Pair trade is always taken together and closed together. If one leg is closed and the other is left open, it's no longer a pair strategy and could result in huge losses.
Any further change in the underlying macros apart from the ones mentioned below may result in significant deviations in the ratio performance and may adversely affect the pair's performance.

Strategy Rationale

The fundamental idea behind the strategy is that well-established top US tech stocks tend to outperform the South African companies over the long run.

This strategy requires an experienced investor to go short on South Africa 40 Index and simultaneously go long on the tech-heavy Index – Nasdaq 100. By doing so, the investor is likely to receive a holding cost of approximately 6.15% p.a. that is currently applicable to the South Africa 40 index. While on the other hand, the person will have to pay a Holding cost of approximately 6.05% p.a., presently applicable on the Nasdaq 100 index. On a net basis, investors could receive holding costs of around 0.10% p.a. (with 2x leverage).

The figures in the table have been derived by undertaking long positions in the US Nasdaq 100 index while simultaneously shorting South Africa 40 index with equal exposure on both sides.

Over the past 16 years, with five times leverage, this strategy would have earned a total profit of almost 445% (estimated average – 11.11% annually) with a hit ratio of 81.25%. As shown in the table, barring three years (2008, 2012 & 2022), Nasdaq 100 has outperformed South Africa 40 every year.

So far this year, Nasdaq 100 outperformed the South African index resulting in a gain of approximately 6% with 2x leverage.

Year Nasdaq
S. Africa 40
Long: NDAQ
Short: SA40
Net holding
cost received
Return post
exposure of $250K
on each investment
Profits/Losses each
year on $100,000
2x lev 2x lev 2x lev 5x lev
2023 YTD 16% 10% 6% 0.1% 6.04% 15% $15,100
2022 -33% 1% -34% 0.2% -33.74% -84% -$84,350
2021 27% 23% 3% 4.9% 8.2% 21% $20,561
2020 48% 7% 41% 1.8% 42.4% 106% $105,914
2019 38% 9% 29% 4.2% 33.1% 83% $82,785
2018 -1.60% -11% 9% 3.4% 12.9% 32% $32,236
2017 31% 20% 11% 4.3% 15.2% 38% $37,936
2016 8% -4% 13% 5.0% 17.6% 44% $43,887
2015 8% 4% 4% 4.8% 8.5% 21% $21,180
2014 18% 6% 12% 4.8% 17.3% 43% $43,305
2013 32% 19% 12% 4.2% 16.6% 42% $41,609
2012 15% 22% -8% 3.9% -3.8% -9% -$9,414
2011 2% -1% 2% 4.1% 6.4% 16% $16,119
2010 18% 15% 3% 4.5% 7.7% 19% $19,208
2009 53% 29% 25% 5.7% 30.6% 76% $76,450
2008 -42% -26% -16% 8.9% -7.2% -18% -$18,124
Estimated Total 178% 445% $444,402
Estimated Return

Data Source: Bloomberg

Date: 08/02/2023

Fundamental Analysis

Last year was challenging for both bonds and shares. The Russian-Ukraine war caused inflation to spike to more than 9% by June 2022, which hyped prices for most commodities and directly affected the markets. Consequently, the US economy faced relentless Federal Reserve rate hikes to control inflation. The fast rise in benchmark interest rate impacted the tech heavy Nasdaq significantly. The Index lost 33% of its value over the year; its top eight companies experienced a 50% or more share-price drop.

Meanwhile, South Africa had a better year, as its economy relies mainly on commodity exports, supporting its financial market. Seemingly in “crisis years”, 2008, 2012 and 2022, South Africa 40 has a tendency to outperform Nasdaq. Nevertheless, what happened in 2022, could turn out to be more of a freak incident with both bonds and stocks declining during the course of the year.

Looking forward, China’s reopening and the layoffs strategy adopted by tech companies to reduce operating costs could help Nasdaq normalise further throughout 2023. The inflation rate has dropped to 6.5%, so interest rate hikes would likely move ahead at a slower pace which is positive for the tech laden index.

Analysts anticipate that the Fed's target rate, currently fluctuating between 4.5% and 4.75%, could peak at 5.132% by July. In other words, the fundamental driver of the tech rally is that the peak in interest rate is nearby.

Interest Rate Trajectory

HI: 0.3306

Data Source: Bloomberg

Date: 08/02/2023

Analysts project that after peaking at near 5.132 percent, the Fed could make two rate cuts of 25 bps each towards the end of 2023.

Technical Analysis

The ratio chart of Nasdaq 100-South Africa 40 shows a potential rebound from a strong 10 year trendline support, offering a good opportunity to enter the NASA trade. In addition, and according to the Stochastic-RSI indicator, the NASA Ratio price is currently trading in an oversold zone, which means, that the pair is positioned well from a return perspective.

NASA Ratio Chart

HI: 0.3306

Data Source: Bloomberg

Date: 08/02/2023

Note: The return calculation includes the holding cost-benefit received on the strategy, and this could change in the future, impacting the strategy either positively or negatively. The returns do not consider the currency depreciation of the Rand. Investors can look to hedge the currency exposure separately.

It is essential to note that Pair Trading is not a risk-free strategy. The diffculty comes when prices of the two securities move contrary to the positions taken, resulting in losses. Thus, adhering to strict risk management rules is vital when dealing with adverse situations.

Data Source: Bloomberg
Data & Prices as of : 08/02/2023

Risks and Assumptions for Back-tested trading strategies
The risks and assumptions listed here are not intended to be an exhaustive summary of all the risks and assumptions involved.
The strategy might suffer from look-ahead bias which occurs due to the 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 losses could be 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 backfill bias.

Data Source: Bloomberg
Data: 30/01/2023

Arun Leslie John
Chief Market Analyst

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