A guest columnist submission courtesy of Rareview Macro
Monday Oct 7 2013
Macro: Long Japan Nikkei after a 6% correction and German DAX against short US S&P 500 allow one to participate in further international equity appreciation should the US Dollar weaken further. This also protects the downside in case there is a short-term sentiment shift away from economic improvement as investors are less willing to look through the issues in Washington. Ahead of Government resolution the stop level for S&P 500 is ~1705 and should trigger an immediate reversal to a long US Equity position. After generating positive performance from the relative value position initially this will then increase ones global beta exposure allowing full participation in the expected strong demand for US equities into year end. The sizing of this strategy should be consistent with trying to capture a significant amount of a 5-7% global equity index rally from current levels.
Micro: Cyclical leadership is well defined and very few are looking to work through a different sector profile. When the US Dollar and S&P 500 were negatively correlated yield proxies outperformed. Conversely, when the US Dollar and S&P 500 were positively correlated signaling a stronger economic profile growth sectors outperformed. The unknown question is what would happen if a return to a weaker US Dollar is followed by S&P 500 either holding the current trading range or appreciating. Point being, will there be a rotation back to yield proxies, especially if Janet Yellen is nominated? It is too early to answer that question but upside options in Utilities (XLU) are a good hedge to this risk profile and why we hold that position.
The argument against this strategy is that “any” Washington resolution is followed by a US Dollar relief rally. Dollar strength may materialize for two or three days but this is only truly wrong if the resolution is a grand bargain which is highly unlikely. Anything less is US Dollar bearish until next year. To access daily notes, please click on icon/logo at the header of this post.