Long Japan; Short US. Market conditions exist for Nikkei-225 index (“Nikkei”) to remain resilient over the next quarter relative to S&P 500
(“S&P”).
BoJ's unflinching commitment to negative rates benefits Japanese firms with a weak Yen. Meanwhile, worsening economic conditions in the US with feeble growth outlook and likely recession could send S&P lower.
This case study illustrates a spread trade between Nikkei and S&P to extract positive yield with compelling upside and limited downside. Entry at 7.011 with target at 7.402 and stop-loss at 6.787.
TAILWINDS SUPPORTING NIKKEI
In a year of crumbling global markets, Nikkei has shown remarkable resilience. YTD Nikkei is down 6% relative to 18% decline in the S&P. Three reasons why:
1. Consistent low interest rates in Japan: Loose monetary policies inflate asset prices. Thanks to a benign monetary stance from the Bank of Japan (BoJ), Nikkei has been and continues to benefit. The BoJ has set its short-term rates at -0.1% and long-term rates at 0%.
2. Weak and weakening Yen: YTD 2022, the Yen is down 20% relative to USD. This helps boost profits for Japanese firms. While most central banks have gone hawkish, the BoJ is resolute in keeping its monetary policy loose. A weak yen makes Japanese assets cheaper. Rising demand for real estate, and a policy framework that incentivises foreign investment boost capital inflow into Japan (e.g.: TSMC new plant in Japan).
3. Pent-up tourism demand boosting travel industry and local spending: Easing pandemic restrictions and opening of borders unlocking pent-up tourism demand is turning the outlook of tourism industry bright.
NIKKEI TECHNICALS
Since October, Nikkei has rallied 11% to its peak on November 25th and 6.5% to its current levels post correction.
The index sits gently above its 200-day moving average which perhaps serves as a support. The stochastic indicator is at 7.4 suggesting that Nikkei may be oversold and positioning for an upward correction.
HEADWINDS FACING S&P 500
While Nikkei sets to soar, S&P appears feeble. US outlook is bleak with structural shifts pointing to slowing demand and job losses. Hawkish Fed with its stance on raising rates to fend off still hot inflation is likely to tip US economy into recession.
a. Growing Recession Fears
Recession looks likely after FOMC rate hike last week. As Chair Powell remarked, while a soft landing was still possible (skirting a recession), the runway for that was becoming shorter.
Fed's stance remains firm and rightfully so. In the last eight (8) rate hike cycles, not once has the Fed eased until inflation print came lower to Fed funds rate. Expecting more rate hikes in 2023 creates downward pressure on the broader economy and the S&P.
US growth outlook for the next year is a mere 0.5%. About 1.6m more could go jobless. In a sign of growing weakness, last Friday, Goldman announced 8,000 staff retrenchment comprising 8% of its workforce.
b. Shrinking Consumer Spending
Uncertain outlook makes consumers wary. Wary consumers spend less. Forecast by Walmart point to structural weaknesses. Weak retail sales are starting to show with no relief signs in sight.
c. While King Dollar has lost some shine, it remains strong
The US Dollar is enjoying a solid performance in decades. Flight to safety amid a world faced with poly-crisis and compounded by a hawkish fed committed to controlling inflation, the dollar remains king.
A strong dollar is not necessarily good news. Rapid dollar ascent has made US goods & services less attractive hurting offshore earnings for the US firms.
TECHNICALS FAVOR NIKKEI OVER S&P
Notwithstanding the above, S&P is up since October rising nearly 20% to its peak on December 13th and 11% to current levels. However, unlike the Nikkei, the S&P is trading below its 200-day moving average which seemingly is impeding as resistance. S&P fell below its ascending channel suggesting that the rally might have lost steam.
INSIGHTS FROM COMMITMENT OF TRADERS REPORT
As seen in the CME Commitment of Traders Report, Hedge Fund positions vindicates our outlook for Nikkei and S&P. Over the last 12 weeks, hedge funds have increased their net short positions by 34% in the CME's E-mini Futures and Micro E-mini futures.
In sharp contrast, during the same period, these participants have increased their net long positions by 18% in CME Nikkei USD and Yen Futures combined.
TRADE CONSTRUCTION
Spread trades using futures require equal notional exposures across both legs.
With S&P at $3,852, one lot of CME's Micro E-Mini contract provides $19,260 in notional exposure while each CME's Nikkei USD futures contract gives $136,160 exposure.
At current levels, equalising notional value requires 7 lots of Micro E-Mini S&P futures for each lot of CME Nikkei Dollar Index Futures.
One (1) lot of long Nikkei 225 futures is required to offset against Seven (7) lots of short Micro E-Mini S&P500 futures.
When Nikkei outperforms S&P500, the spread trade delivers positive returns.
Outperformance could manifest in one of three ways: (a) Nikkei rises while S&P falls, or (b) Both Nikkei and S&P rise but Nikkei rises more than S&P, or (c) Both Nikkei and S&P fall but Nikkei falls lesser than S&P. If the reverse of these three scenarios occurs, then the spread trade loses money.
MARKET DATA
CME Real-time Market Data help identify trading set-ups and express market views better. If you have futures in your trading portfolio, you can check out on CME Group data plans available that suit your trading needs www.tradingview.com/gopro/
DISCLAIMER
Trade ideas cited above are for illustration only, as an integral part of a case study to demonstrate the fundamental concepts in risk management under the market scenarios being discussed. They shall not be construed as investment recommendations or advice. Nor are they used to promote any specific products, or services.
This material has been published for general education and circulation only. It does not offer or solicit to buy or sell and does not address specific investment or risk management objectives, financial situation, or particular needs of any person.
Advice should be sought from a financial advisor regarding the suitability of any investment or risk management product before investing or adopting any investment or hedging strategies. Past performance is not indicative of the future performance.
All examples used in this workshop are hypothetical and are used for explanation purposes only. Contents in this material is not investment advice and/or may or may not be the results of actual market experience.
Mint Finance does not endorse or shall not be liable for the content of information provided by third parties. Use of and/or reliance on such information is entirely at the reader’s own risk.
These materials are not intended for distribution to, or for use by or to be acted on by any person or entity located in any jurisdiction where such distribution, use or action would be contrary to applicable laws or regulations or would subject Mint Finance to any registration or licensing requirement.
(“S&P”).
BoJ's unflinching commitment to negative rates benefits Japanese firms with a weak Yen. Meanwhile, worsening economic conditions in the US with feeble growth outlook and likely recession could send S&P lower.
This case study illustrates a spread trade between Nikkei and S&P to extract positive yield with compelling upside and limited downside. Entry at 7.011 with target at 7.402 and stop-loss at 6.787.
TAILWINDS SUPPORTING NIKKEI
In a year of crumbling global markets, Nikkei has shown remarkable resilience. YTD Nikkei is down 6% relative to 18% decline in the S&P. Three reasons why:
1. Consistent low interest rates in Japan: Loose monetary policies inflate asset prices. Thanks to a benign monetary stance from the Bank of Japan (BoJ), Nikkei has been and continues to benefit. The BoJ has set its short-term rates at -0.1% and long-term rates at 0%.
2. Weak and weakening Yen: YTD 2022, the Yen is down 20% relative to USD. This helps boost profits for Japanese firms. While most central banks have gone hawkish, the BoJ is resolute in keeping its monetary policy loose. A weak yen makes Japanese assets cheaper. Rising demand for real estate, and a policy framework that incentivises foreign investment boost capital inflow into Japan (e.g.: TSMC new plant in Japan).
3. Pent-up tourism demand boosting travel industry and local spending: Easing pandemic restrictions and opening of borders unlocking pent-up tourism demand is turning the outlook of tourism industry bright.
NIKKEI TECHNICALS
Since October, Nikkei has rallied 11% to its peak on November 25th and 6.5% to its current levels post correction.
The index sits gently above its 200-day moving average which perhaps serves as a support. The stochastic indicator is at 7.4 suggesting that Nikkei may be oversold and positioning for an upward correction.
HEADWINDS FACING S&P 500
While Nikkei sets to soar, S&P appears feeble. US outlook is bleak with structural shifts pointing to slowing demand and job losses. Hawkish Fed with its stance on raising rates to fend off still hot inflation is likely to tip US economy into recession.
a. Growing Recession Fears
Recession looks likely after FOMC rate hike last week. As Chair Powell remarked, while a soft landing was still possible (skirting a recession), the runway for that was becoming shorter.
Fed's stance remains firm and rightfully so. In the last eight (8) rate hike cycles, not once has the Fed eased until inflation print came lower to Fed funds rate. Expecting more rate hikes in 2023 creates downward pressure on the broader economy and the S&P.
US growth outlook for the next year is a mere 0.5%. About 1.6m more could go jobless. In a sign of growing weakness, last Friday, Goldman announced 8,000 staff retrenchment comprising 8% of its workforce.
b. Shrinking Consumer Spending
Uncertain outlook makes consumers wary. Wary consumers spend less. Forecast by Walmart point to structural weaknesses. Weak retail sales are starting to show with no relief signs in sight.
c. While King Dollar has lost some shine, it remains strong
The US Dollar is enjoying a solid performance in decades. Flight to safety amid a world faced with poly-crisis and compounded by a hawkish fed committed to controlling inflation, the dollar remains king.
A strong dollar is not necessarily good news. Rapid dollar ascent has made US goods & services less attractive hurting offshore earnings for the US firms.
TECHNICALS FAVOR NIKKEI OVER S&P
Notwithstanding the above, S&P is up since October rising nearly 20% to its peak on December 13th and 11% to current levels. However, unlike the Nikkei, the S&P is trading below its 200-day moving average which seemingly is impeding as resistance. S&P fell below its ascending channel suggesting that the rally might have lost steam.
INSIGHTS FROM COMMITMENT OF TRADERS REPORT
As seen in the CME Commitment of Traders Report, Hedge Fund positions vindicates our outlook for Nikkei and S&P. Over the last 12 weeks, hedge funds have increased their net short positions by 34% in the CME's E-mini Futures and Micro E-mini futures.
In sharp contrast, during the same period, these participants have increased their net long positions by 18% in CME Nikkei USD and Yen Futures combined.
TRADE CONSTRUCTION
Spread trades using futures require equal notional exposures across both legs.
With S&P at $3,852, one lot of CME's Micro E-Mini contract provides $19,260 in notional exposure while each CME's Nikkei USD futures contract gives $136,160 exposure.
At current levels, equalising notional value requires 7 lots of Micro E-Mini S&P futures for each lot of CME Nikkei Dollar Index Futures.
One (1) lot of long Nikkei 225 futures is required to offset against Seven (7) lots of short Micro E-Mini S&P500 futures.
- Entry: 7.013
- Target: 7.402, Potential Profit: $7,783
- Stop Loss: 6.776, Potential Loss: $4,177
- Reward/Risk Ratio: 1.86
When Nikkei outperforms S&P500, the spread trade delivers positive returns.
Outperformance could manifest in one of three ways: (a) Nikkei rises while S&P falls, or (b) Both Nikkei and S&P rise but Nikkei rises more than S&P, or (c) Both Nikkei and S&P fall but Nikkei falls lesser than S&P. If the reverse of these three scenarios occurs, then the spread trade loses money.
MARKET DATA
CME Real-time Market Data help identify trading set-ups and express market views better. If you have futures in your trading portfolio, you can check out on CME Group data plans available that suit your trading needs www.tradingview.com/gopro/
DISCLAIMER
Trade ideas cited above are for illustration only, as an integral part of a case study to demonstrate the fundamental concepts in risk management under the market scenarios being discussed. They shall not be construed as investment recommendations or advice. Nor are they used to promote any specific products, or services.
This material has been published for general education and circulation only. It does not offer or solicit to buy or sell and does not address specific investment or risk management objectives, financial situation, or particular needs of any person.
Advice should be sought from a financial advisor regarding the suitability of any investment or risk management product before investing or adopting any investment or hedging strategies. Past performance is not indicative of the future performance.
All examples used in this workshop are hypothetical and are used for explanation purposes only. Contents in this material is not investment advice and/or may or may not be the results of actual market experience.
Mint Finance does not endorse or shall not be liable for the content of information provided by third parties. Use of and/or reliance on such information is entirely at the reader’s own risk.
These materials are not intended for distribution to, or for use by or to be acted on by any person or entity located in any jurisdiction where such distribution, use or action would be contrary to applicable laws or regulations or would subject Mint Finance to any registration or licensing requirement.
Trade closed: stop reached:
Days after our case study was published the BoJ announced a change in its YCC by widening the range and allowing interest rates to move +-50bps away from the target 0% rate. This effectively acted to raise interest rates by 25bps. This move led to the Nikkei 225 crashing sharply (-7%) while the S&P 500 leg of the trade remained unaffected by this move. This led the ratio of the spread trade to decline to our stop level which led to a loss of $4,177 or -28.9% ROIC.
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