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Paratrade Systems Weekly Research News

16 Aug

How much does the S&P get its queue from emerging markets?

There is a little turmoil in the stock market as Turkey is having some diplomatic problems with the rest of the world. This has dragged down many other emerging markets creating a rather stark divergence between the S&P and the SPEM (the ETF we’ll use as a benchmark index). The question at hand is how does this usually resolve itself?

If we sold the S&P the next day after the 10-day momentum of EM fell below  -3 (ignoring its relative performance to EM) -how did we do?

Wow – terrible. EM doesn’t naturally pull down the S&P when it sinks. In fact, if you wait for SPEM to tank you should buy the S&P in anticipation of a bounce in either the S&P, the EM or both. Let’s look at the problem another way:

The spread is a volatility and trend adjusted differential. We can see both the 5-day and the 10-day spread in the chart. We can then test to see how the S&P behaves when it is very rich vs. SPEM. I’ll spare you the details – it really doesn’t matter (to the S&P) how expensive it is vis a vis the SPEM – over the last 10 years. The only time they were in sync was August – October 2015.

Conclusion

Things may change in the future but for now:

  • If the S&P gets pulled down by the SPEM then it’s probably a buy and
  • Don’t short the S&P after an SPEM decline even if the S&P is rich.

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