I've been looking at a spread trade between two stock indices lately: long Hang Seng vs short the Australian ASX 200.
There are a few reasons to like this trade. Over the past year, Chinese stocks have underperformed global stock indices, while Australia has kept pace. Year-to-date, the ASX is up 6.8% while the HSI is down 2.7%; since this time last year, those numbers read +13.7% and +4.9% respectively.
On a macro level, with the global downturn in commodities I expect upcoming Australian economic numbers to suffer - and feel that China slowdown fears are overdone (it is still by some distance the fastest growing large economy in the world).
A look at the HSI to ASX ratio as a time series below suggests this to be a good entry point for a mean reversion play. The current ratio is around 4.3 where the mean is about 4.7.
In general also the ratio trade performs well when both stocks are at high levels - the current value (marked in red below) is quite an outlier.
There are a few ways to put on this trade. Perhaps the simplest way is via volatility balanced (roughly 4:1) sizes in a spread-betting account, to avoid currency effects. Stop-loss the ratio at 4.15, the lowest point of the last 3 years, and target a return to 5.0.
Note: Another good reason to be bearish the ASX follows from my analysis of P/E vs sovereign yields earlier this week. The P/E ratio for the ASX is 21, higher even than the S&P 500 - despite 10yr yields in Australia being roughly double that of those in the US (by contrast, the P/E for the Hang Seng currently is 11).
There are a few reasons to like this trade. Over the past year, Chinese stocks have underperformed global stock indices, while Australia has kept pace. Year-to-date, the ASX is up 6.8% while the HSI is down 2.7%; since this time last year, those numbers read +13.7% and +4.9% respectively.
On a macro level, with the global downturn in commodities I expect upcoming Australian economic numbers to suffer - and feel that China slowdown fears are overdone (it is still by some distance the fastest growing large economy in the world).
A look at the HSI to ASX ratio as a time series below suggests this to be a good entry point for a mean reversion play. The current ratio is around 4.3 where the mean is about 4.7.
In general also the ratio trade performs well when both stocks are at high levels - the current value (marked in red below) is quite an outlier.
Note: Another good reason to be bearish the ASX follows from my analysis of P/E vs sovereign yields earlier this week. The P/E ratio for the ASX is 21, higher even than the S&P 500 - despite 10yr yields in Australia being roughly double that of those in the US (by contrast, the P/E for the Hang Seng currently is 11).
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