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| Short S&P 500, long Dow |
| Mukul Pal / Jul 20, 2009, 00:53 IST |
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Performance cycles can shed some light on where Sensex and global equities are headed
American equity pairs: A global pair relationship between S&P 500 and DOW 30 illustrates the relationship between the broad 500 stocks and 30 blue chips. The two indices have performance-underperformance cyclicality against each other. The pair hit a cycle low, both on an intermediate and primary basis on November 23, 2008. This suggested that the broad 500 blue chips could not underperform the top 30 American blue chips any more. Why? Because performance cycles are based on time fractals, there is an order in which broad market performs or underperforms the blue chips. Market turnarounds have a lot to do with the respective dynamics.
A sustained turnaround cannot happen without a broad market rise. If the broad markets start to lag the blue chips on a primary performance cycle, markets may be reaching a primary top. On the other hand if broad market starts to outperform blue chips. It may be a good time for primary allocation in equities.
Based on this reason November lows were times when inability of broad market to crack against blue chips was suggesting a reversal. What happened was that markets not only bottomed but the broad S&P 500 pair against Dow made 10 per cent returns non-leveraged in 200 days. This means 18 per cent on an annualised basis, enough to excite the best fund managers in the world. Making money buying the Dow and selling S&P 500 is what time fractals are all about. They not only indicate a market direction but also explain economic perspectives with pairs.
Now starting June 14, the markets hit resistance and S&P 500 has also hit a performance cycle high against the Dow. What does this mean? This means that the broad market may continue to underperform for at least a few months. When broad markets fall against blue chips, gains become shallow and unsustainable. Another interesting aspect to be observed here is that it is only now after November that the broad market has turned lower against the Dow. This removes any doubt for us that the intermediate path of least resistance remains lower not higher for American equities.
Indian equity pairs
On a primary basis, markets have witnessed about 10 performance tops on BSE 500 against BSE Sensex since 2000. Barring one signal, rest came at or near historical tops viz. March 2002, January 2004, and January 2008. Where are we on BSE 500 vs. the Sensex now? The performance cycle between BSE 500 and the Sensex just like its global peer is at an extreme. This might look like a coincidence, but even if there is a relative performance cycle between the Dow and the Sensex, global equities move together.
The broad market indices weakening against blue chip indices don't excite us. They tell us that the best part of the 2009 bull reprieve is over and whatever reason we may give us, the odds are against us as equity owners. India is a great story. It will be always be a great story. But if the broad market depicted by BSE 500 decides to falter against Top 30 stocks, markets are heading for at least a month or two of exhaustion. The post-June low which could push markets higher seems a bit distant at this stage.
Cross pairs
Then there are cross pairs. The anticipated turn on oil we spoke about in this column some time ago, happened. Prices fell nearly 23 per cent from June highs. Now conventionalists might call it another random forecast that just got lucky. But then this is not all we said. We also talked about the long Dow, short oil pair. At the time we were negative on both Dow and oil. To be able to understand that both the Dow and oil were going down and also anticipate that oil will fall more than the Dow is extreme luck. The pair made 8 per cent over the last 41 days.
Performance cycles were clearly skewed in favour of the Dow in the Dow-oil pair though both were negative. Now the news linked to macroeconomic factors like 'lower oil prices leading to lower trade deficits in the US leading to a stronger dollar leading to lower oil prices' should start appearing. Media will now ask “Does Dollar weakness cause high Oil prices?” or the opposite “Does Dollar strengthening cause low Oil prices?”, “Oil prices up, Dollar down - coincidence?” , “Oil prices down, Dollar up - coincidence?” etc. . If one looks at the performance cycles between BRT and the dollar index, performance cycles give cues for cross asset perspectives.
Metal pairs
Golden outperformance: long gold-short oil (up 8 per cent from June 2), gold vs steel (up 18 per cent from June 4) and long gold - short silver (up 3 per cent). Either this is a string of coincidences or performance cycles really work. Mind it these are just gold-related pairs, we have already demonstrated performance cyclicality with other equity and cross asset pairs. Most of the performance cycles still suggest that gold is in for a multi-month outperformance. Is there something wrong with gold? Why is it ready to outperform? What is it signaling? Is this not in sync with the broad market - blue chip pair we are speaking about.One aspect which stands out unequivocally is that gold leads the metals complex. The crisis commodity is ready to rise against most metals. This leadership against metals, equities and commodities like oil also suggest that our underperformance case on equities and oil should continue.
Our preferred view on gold is up with prices still holding $900-925 an ounce levels. The rest of the metals continue to move lower. Barring uranium, gold is up against every other metal in the metals complex. Against platinum, Gold delivered 11 per cent. In conclusion, pair performance demonstrates the mathematical nature of time and how markets move from disequilibrium to equilibrium oscillating in an ordered fashion. We can keep trying to avoid time, ignore it, but it will continue to manifest in various forms, various global pairs creating risk and return in a fractalled way telling us that shorting the S&P 500 and going long on the Dow may not be such a bad idea after all.
This is a perspective product and not a strategy product. Long -short strategies are not riskless strategies.
The author is CEO, Orpheus CAPITALS a global alternative research firm
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