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Thursday, February 17, 2022

Russell Small Cap – SPX Mid Cap

By Century Financial in 'Investment Insights'

Russell Small Cap – SPX Mid Cap
Russell Small Cap – SPX Mid Cap

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

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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.

Risks & Assumptions

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Past performance is not indicative of and does not guarantee future results. Please read the complete disclaimer carefully.
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Holding cost is subject to change impacting the trade either negatively or positively.
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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.
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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.

Strategy: Long Russell Small Cap – Short SPX Mid Cap

The chart below depicts the ratio between Russell Small Cap and SPX Mid Cap

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The ratio between Russell Small Cap and SPX Mid Cap
Date: 16th Feb 2022
Source: Bloomberg

The ratio between the two indices has fallen to a ten-year low of 0.7633. In 2016, the ratio rebounded from similar levels and rallied up to 0.8523 in 2018.

Tailwinds for Small Cap

Smaller-company stocks have suffered as the Fed reduces stimulus. But the reopening of the economy will change that. In addition, three tailwinds favor small-cap compared to mid-cap securities.

1. Optimistic Earnings Outlook
The forecasted growth from small-cap stocks is brighter for the upcoming quarters than mid-cap securities. Russell Small Cap is expected to rally by 24 percent and 19 percent over the 1st two quarters of 2022 respectively, while SPX Mid Cap is expected to grow by only 3 percent and 10 percent during the same time frame.

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Earnings Growth Forecasts
Date: 16th Feb 2022
Data Source: Bloomberg

2. A Strong Economy Supports Smaller Enterprises
Smaller companies tend to be based on cyclical businesses, and the cyclical companies do better when the economy is strong. So, while these companies were hit harder by the Covid-related lockdowns because they usually have less diversified businesses, they have more room to improve as Covid recedes and the economy gets back to normal.

3. Correlation to Consumer Confidence
While consumer confidence was low when the pandemic struck, the global market outlook has improved ever since the worries of Omicron have slid. Consumer confidence is expected to rise as jobless claims reduce and inflation eases.

Risks and Assumptions for Back-tested trading strategies
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The risks and assumptions listed here are not intended to be an exhaustive summary of all the risks and assumptions involved.
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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.
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Future price movements may not be exactly the same as the historical price movements and this could lead to variation in performance.
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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.
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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.
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Drawdowns in actual trading can be higher than the tested system and losses could be significant in the event of leverage.
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Unforeseen events can lead to variation in performance from the tested trading strategy.
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The tested result has been computed with price feeds available from Bloomberg.
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The testing environment has not considered transaction or any other costs.
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Trading indicators used for the purpose of testing has been provided by Bloomberg.
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The strategy might suffer from data mining fallacy, selection bias and backfill bias.

Data Source: Bloomberg
Data & Prices as of: 16/02/2022

Arun Leslie John
Chief Market Analyst

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