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Wednesday, July 14, 2021
Will markets witness a repeat of 2014 & 2015?
*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
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.
At its latest FOMC meeting on 16 June 2021, US Federal Reserve stunned the markets by its surprisingly hawkish tilt where 7 members were expecting a rate hike in 2022 and 11 members were in favor of 2 rate hikes in 2023.
With rate hikes penciled in sooner than expected, markets expect the Federal reserve will move closer to talking about tapering. A move like this would tame inflation and slow economic growth, thus resulting in a flattening yield curve. If long-term growth falls, it will lead to subdued long-term yields, whereas short-term yields will stay firm as Fed is withdrawing the monetary stimulus. Markets are already discounting a Fed taper by the beginning of next year.
Following the Fed taper in Dec 2013 and ahead of the rate hike in Dec 2015, 2/10-year spread flattened by 143bps. This time around, the signal from the Fed has kicked o a sequence, which has already shaved 18 bps off the curve. But history suggests there is still a long way to go!
Back in 2014 & 2015 when the yield curve flattened, the US Dollar rallied against most of its counterparts while commodities which are denominated in Dollar took a beating. With the strength in Dollar, US assets seemed more attractive than the emerging and developed counterparts and this resulted in the outperformance of US stock markets. Besides, last time the treasury yields flattened, Health care, Tech, Consumer Discretionary, Real estate sectors outperformed the market, while industrials, materials energy and financial sectors underperformed.
Historical Performance of major instruments in 2014-15 ahead of the rate hike!
|Currency||2014-2015 Returns %|
|COMMODITIES||2014-2015 Returns %|
|BRENT CRUDE OIL||-67%|
|Indices||2014-2015 Returns %|
|US NASDAQ 100 INDEX||30%|
|US SPX 500||12%|
|US SPX MID 400||4%|
|US SMALL CAP||-3%|
|GERMANY TECH 30||57%|
|INDIA 50 INDEX*||26%|
|SOUTH AFRICA (TOP 40) INDEX||11%|
|FRANCE 40 INDEX||9%|
|EUROPE 50 INDEX||6%|
|GERMANY 30 INDEX||12%|
|AUSTRALIA 200 INDEX||-1%|
|UK FTSE 100 INDEX||-7%|
|Sectors||2014-2015 Returns %|
|S&P 500 HEALTH CARE INDEX||31%|
|S&P 500 INFO TECH INDEX||26%|
|S&P 500 REAL ESTATE INDEX||28%|
|S&P 500 CONS DISCRETIONARY INDEX||19%|
|S&P 500 CONS STAPLES INDEX||18%|
|S&P 500 UTILITIES INDEX||15%|
|S&P 500 FINANCIALS INDEX||11%|
|S&P 500 INDUSTRIALS INDEX||4%|
|S&P 500 MATERIALS INDEX||-5%|
|S&P 500 ENERGY INDEX||-31%|
*India-50 rallied significantly in 2014 primarily on account of optimism surrounding the win of Prime Minister Narendra Modi.
If history does repeat itself, which looks likely, the Dollar could rally alongside defensive & growth stocks while cyclical stocks and commodities could underperform. Meanwhile, with the US Federal Reserve likely to be relatively more hawkish than its emerging and developed counterparts, US assets are likely to remain more attractive.
Investors looking to capitalize on the flattening of the yield curve can consider the following trades:
|Indices||2014-2015 Returns %|
|German tech 30 vs Spain 35||60%|
|US Fang Plus vs Russell||24%*|
|Nasdaq 100 vs South Africa 40||19%|
|Netherlands 25 vs Spain 35||14%|
|Euro 50 vs UK 100||13%|
|SPX 500 vs SPX mid-cap 400||8%|
|Share Baskets||2014-2015 Returns %|
|Collaborative tech vs Canada 60||44% **|
|Big Tech + Mobile Payment vs SPX Midcap 400||21.4%**|
Exchange Trade Funds
|ETFs||2014-2015 Returns %|
|VANGUARD HEALTH CARE ETF||31%|
|INVESCO QQQ TRUST SERIES 1||27%|
|ISHARES US REAL ESTATE ETF||19%|
|CONSUMER DISCRECTIONARY SPDR FUND||17%|
|ISHARES US UTILITIES ETF||13%|
*The returns have been calculated from Launch date of US Fang Plus - 22nd Sep 2014
**Share baskets have been back tested on the current constituent weights and hence the results are subject to backfill bias and selection bias.
Besides, data for select stocks like Docusign, Zoom video, Square, Paypal among others was not available since the start as they were not listed in 2014-15. For example, Docusign was listed in the year 2018. In such instances, for the days prior to listing, the weightage of Docusign has been distributed among the other stocks on the basis of their individual weights.
Disclaimer: Past Performance doesn’t guarantee future returns.
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.
Individual stocks in the basket are subject to both weightage recalculation & recomposition risk. As a result, certain stocks may be added or removed from the basket as per the platform provider purview without any advance notification. This may be specific to any individual stock or due to some sector specific event. Consequently, share basket performance may significantly deviate from the one specified below.
Risks and Assumptions for Back-tested trading strategies
Data Source: Bloomberg
Arun Leslie John
Chief Market Analyst
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