Who to bank on?

Absa or FirstRand

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