Who to bank on?

Absa or FirstRand

Financial Mail - Investors Monthly - - Front Page -

While the longert­erm fate of the global mar­ket land­scape is in flux, with mar­kets pretty much in no-man’s-land, it is dif­fi­cult to take a view in terms of which stocks can be traded in the shorter term with rel­a­tive safety.

Thus, the strat­egy this month is not to take a di­rec­tional “bet” on what the mar­ket might do, but to fo­cus on the rel­a­tive per­for­mance of two shares in the same sec­tor.

The trade idea is there­fore a pair trade.

In­stead of fo­cus­ing on the price of just one stock and trad­ing for an an­tic­i­pated move­ment in one di­rec­tion (long or short), you are trad­ing the re­la­tion­ship be­tween two stocks and the change in that re­la­tion­ship, in terms of how they per­form when com­pared.

FirstRand has for some time been the pack leader among the banks as it was favoured by an­a­lysts and fund man­agers. Re­cently, though, the torch has been passed to Absa and FirstRand has fallen out of favour. This is shown by the charts of each stock.

Note that this trade idea is based on share price data up to Fe­bru­ary 12.

In­di­cated in the chart above, we see that the rel­a­tive per­for­mance of FirstRand ver­sus the top 40 in­dex has started to trend lower.

What this means is that FirstRand’s per­for­mance is grad­u­ally be­com­ing worse when com­pared to the top 40 in­dex.

Al­though the share price it­self may move higher in com­ing weeks, as well as the over­all mar­ket, FirstRand’s share price is not ex­pected to per­form as well as the over­all mar­ket.

In other words, if the mar­ket moves higher, FirstRand is ex­pected to move higher as well, but not by as much as the mar­ket.

Con­versely, if the mar­ket comes down, FirstRand’s share price is ex­pected to come down more than the mar­ket does.

On the flip side is the Absa Group, also in­di­cated in the chart, be­low left. Here we see that Absa has been a rel­a­tive un­der­per­former (like FirstRand is now) in the past and has re­cently be­come a rel­a­tive out­per­former.

This means that it is be­hav­ing ex­actly the op­po­site way that FirstRand is.

When the mar­ket moves higher, Absa ral­lies harder than the over­all mar­ket, and when the mar­ket moves lower, Absa does not fall as hard.

This then lays the foun­da­tion for our pair trade.

In the chart be­low we see the his­toric re­la­tion­ship be­tween Absa and FirstRand. For some time, the Absa share price was more than triple the FirstRand share price. This ra­tio was tested and roughly main­tained for some time, un­til FirstRand started gain­ing ground on Absa, as in­di­cated on the chart by the ra­tio mov­ing to Absa’s share price be­ing around roughly two times that of FirstRand’s.

Since De­cem­ber 2018, this re­la­tion­ship has started mov­ing back to its his­toric norm of Absa’s share price be­ing around three times that of FirstRand’s.

I ex­pect to see an over­cor­rec­tion here, with that ra­tio overex­tend­ing to well above three times Absa over FirstRand, and then set­tling once more com­fort­ably above three. Petri Redel­inghuys

FirstRand has for some time been the pack leader among the banks, favoured by an­a­lysts and fund man­agers. Re­cently, though, the torch has been passed to Absa

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