Financial Mail - Investors Monthly
TRADE OF THE MONTH
How to get exposure to rising US market, depending on your willingness to take risks
“The S&P 500 index has breached the significant resistance level it formed in October and November 2018. It is in the process of forming a new high and so we can say the trend is once again up
Iwant to start by admitting that I am bearish, and that being a bear is often a painful experience. Though there are many fundamental and macroeconomic reasons to be bearish, the plain fact is that markets are going higher. Over the past few months I have been eyeing a, so to say, line in the sand that, during the past month, has been breached. My view must change to embrace the probability that global markets, particularly the US market, will continue to rise.
Seeing as our job as market participants is not to forecast, but to follow, I want to position myself in such a way that I can take advantage of the upward momentum of the US market. A long position in Sygnia Itrix MSCI USA ETF (Sygus) is a great way to gain access to S&P 500 returns locally.
Using the chart on this page, we can see that the S&P 500 index has breached the significant resistance level it formed in October and November 2018. This means it is in the process of forming a new high and so we can say the trend is once again up.
From a probability perspective it is more likely that the S&P 500 will continue to make new record highs than it is likely for it to retest the lows made in December.
While using the same level that dictated the sentiment change from bearish to bullish as a stop-loss for the long S&P 500 position, we can use the NewWave USD ETN (NEWUSD) to either hedge out the currency risk on the trade, or to try to capture additional profit by essentially doubling the currency risk.
That all sounds rather complicated, so I will simplify. The Sygus ETF invests in the same shares that make up the S&P 500 index, therefore it mirrors the market performance that the S&P 500 gives. And because this ETF is invested in the US but converted and denominated in SA rands, the value of the ETF fluctuates based on both the S&P 500 index performance and the rand/dollar exchange rate.
This means that in a scenario where the rand weakens and the S&P 500 rallies, the Sygus ETF will outperform the S&P 500 (in rand terms).
In a scenario where the rand strengthens and the S&P 500 index comes down, the negative performance will similarly be exacerbated. This leaves us with three options: low-risk, medium-risk and high-risk.
The long and the short
The low-risk trade would be to enter into a long position on the Sygus ETF and simultaneously enter into a short position (by making use of CFDs) on the NEWUSD ETN, both positions being as close as possible to each other’s rand value in terms of nominal exposure (for instance, R50,000 long Sygus and R50,000 short NEWUSD). When combined this will effectively remove all the influence that changes in the rand/dollar exchange rate has on the value of the Sygus ETF, thereby isolating only the performance of the S&P 500 index and providing that as a return.
Unfortunately this means that in a scenario where the rand weakens, the short position on the NEWUSD ETN will take a loss equivalent to the additional return that is earned on the Sygus ETF. But in a scenario where the rand strengthens, the short position in the NEWUSD ETN will profit by the same amount that the Sygus ETF will underperform the S&P 500 index.
Just go long
The medium-risk trade is a lot simpler, as it is merely to take a long position in the Sygus ETF. In this trade the return earned will fluctuate based on both the return of the S&P 500 index and the rand/dollar exchange rate. Therefore in a scenario in which the rand weakens and the S&P 500 rallies, the trade will outperform the S&P 500 index; however, if the rand strengthens the trade will underperform.
The long-long route
The high-risk trade is to enter into a long position on both the Sygus ETF and the NEWUSD ETN, again of similar nominal exposure value. If the rand weakens and the S&P 500 rallies, the trade will strongly outperform the S&P 500 index. It will provide double the amount of excess return that rand weakness would provide under normal circumstances.
A word of warning: in the event that the rand strengthens, this trade will sharply underperform the S&P 500 index and could lead to relatively large losses, should the rand strengthen and the S&P 500 come down. It is recommended that only investors and traders with very high-risk appetites consider this trade.
In all three of these scenarios it is recommended that the stop-loss be placed either at the support level as indicated on the chart (more aggressive); or just below the lower extreme of the consolidation between September and November 2018 (as indicated on the chart).