A Pair Trade With NASDAQ

Looking at the hard facts as well as by smelling the sweet and sour aroma of money being made, technology companies seem to be poised to gain in this economic environment. 

Let’s assume a null scenario of the U.S. economy and make exogenous unpredictable events constant so that they do not effect our perception of the null scenario. Under our simplified economic precept we see:

• A beginning of a new economic cycle
• Aftermath of a debt crisis
• Inflationary pressures
• Distressed dollar   

We are technically undergoing a brand new economic cycle one that most likely will not be like the past three or four cycles. Experts in capital markets and the economy predict that the U.S. will experience what the Japanese have experiences for the past decade or there’s the possibility that we experience a Western Europe economic cycle. Most likely it will be a mix of the two depending on our level of productivity. Essentially, this is a top-down thesis of entrenchment that has been mentioned will be mirrored in the markets all else remaining equal.

There are also inflationary pressures which on balance have brought up the tide for technology companies via Google, Facebook, Apple, Sun Mic, Linked In, etc. What this means is there most likely will be a follow through of price appreciation assuming that this money from the lifted tide is recycled. And tech. companies have quite a desire for investments and capital markets!

Additionally, this fresh new economic cycle is coming off the heels of a pandemic debt crisis this is ongoing. Typically debt related recessions have lasting effects and so the wounds linger. Companies with a lot of debt and debt-related problems will only perform well during times of economic relief and stimulus. Simply put, a company with little to no debt has less risk and more ability to gain during duress. NASDAQ companies are ones with little to no debt on their balance sheets. That means that the NASDAQ will be better positioned to appreciate versus the S&P 500 which is more debt-laden.

Why not just buy the NASDAQ?

Even though NASDAQ tech. companies are positioned better and should do well they still hold risk. That risk includes liquidity risk and market risk. With that said, the pair trade ameliorates the risk profile of your investment because the short side negates the liquidity and market risk while still positioning for a gain.

All things remaining equal, the NASDAQ index is more volatile than the S&P 500 which means it would be best to put the trade on during perceived market bottoms. Although no one can predict the markets it’s a great way to measure into the investment because the trade does very well from the bottom going back up. Since we are bouncing off a perceived market bottom this trade is advisable now.