Trade Alert

Long/Short pair trade idea for Mega Cap Tech

_{Posted by Club Member Bonds 1.9.23}

This trade was actually inspired by some of the discussions on here! Many of the Mega Cap names sold off 10%-15% during August and are now starting to recover. I think now would be a good time to move back into these stocks.

The recent price action for Apple, Microsoft, Tesla, and Meta looks positive, and technical indicators for these stocks are suggesting that the short-term pullback may be behind us.

BUT being “naked long” these tech stocks is not without risks. The biggest risk being their expensive valuations driven largely by PE multiple expansion this year. Being short the long-end of the US treasury yield curve can help mitigate this risk.

Scenario analysis:

Scenario 1. Bond yields begin to rise again, leading to PE multiple compression. The Long tech position takes a hit, but losses here are offset by the profits from the Short position in treasury bonds. End result = small net gain.

Scenario 2. Bond yields fall meaningfully after rising since April, leading to PE multiple expansion. Here, Tech stocks in general will do well. Gains from Tech position offsets losses from being short treasury bonds. End result = small net gain.

Scenario 3. Bond yields stay mostly flat. Mega cap tech continues to power upwards through to year end as investors chase the few companies with robust and predictable earnings growth at a time when the macro backdrop is increasingly uncertain. Long Tech position gains, while short treasury position does nothing. End results = good gains.

Scenario 4. A black swan even occurs, the stock market crashes, and investors rush into the safest asset, that being US Treasury bonds, sending bond price higher and yields lower. In this scenario, both the long tech position and short US treasury bonds position will take losses. End result = losses x 2.

It seems to me that this pair trade (Long mega cap tech/ Short US Treasury bonds) provides very attractive risk-adjusted payoffs, as described above. The only scenario where this trade fails is if a black swan event crashes the stock market, but you can never really hedge your portfolio for that.

I think scenario 3 is most likely. Bond yields will probably stay ranged bound around where they are now, essentially “higher for longer” but mega cap tech will be able to withstand yields at these levels given the quality of their businesses and earnings growth.

#New Ideas #Mega Cap Tech #US Bond Yields

To follow the discussion on Pair Trading Mega Cap Tech and for more trade ideas visit the Daily Market Exchange.

Recent posts from the Daily Market Exchange:

1. Tesla is reported to have made another round of price cuts in China!

   I know some members here are bullish on Tesla, but is anyone concern that further weakness in the Chinese economy will lead to more price cuts, leading to more margin pressure for Tesla? If margins do not stabilize soon, investors may punish the stock! Tesla fell from $293 in mid-July to $215 by mid-August, maybe part of that correction was the markets pricing in Tesla’s near-term margin challenges? The stock closed yesterday at $258, so the recovery from the bottom in August is also meaningful. Just trying to decide if the stock price today has properly discounted the risk surrounding Tesla’s operating margins for the next few quarters, if so, maybe it's worth buying some Tesla stock here?

   Click here to continue reading and/or to join the discussion on Tesla

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