The market began to embrace a risk-off posture during mid-February, and we're seeing signs that it is spreading.
Large cap low volatility stocks (SPLV) have been outperforming their high beta (SPHB) counterparts since mid-February, a sign that underneath the surface there has been a rotation to what are perceived as safer stocks.
The ETF parks its funds in stocks that are more defensive, and tend to move less in terms of realized volatility. The holdings include companies like Coca-Cola, Clorox, Johnson and Johnson and McDonalds.
In this end cycle environment, where odds of recession are on the rise along with interest rates, money tends to flow towards parts of the market that are likely to be more resilient.
This is a sign that defensive posturing, rather than risk taking, is being embraced after the powerful countertrend pop we experienced from October.
What's curious is that these flows started well before any banking concerns surfaced to the public. Instead they seemed to emerge when there was an imbalance of positioning and sentiment toward the long side.
One pair trade idea to consider is long SPLV and short SPHB, whether it is put on using the ETFs, options, or otherwise. The reason is that it appears that the relative strength of SPLV is likely to continue vs SPHB. This would be a longer term swing trade that is based on the premise that the risk-off flight to safer parts of the market continues.
It is important to remember that with pair trades both sides of the book should be re-balanced periodically, and that the weightings are often best expressed by matching each side of the trade by their relative volatility.
I'd get out of this trade if I observed that SPLV's relative strength vs SPHB was fading. For now it appears quite healthy with the potential for it to continue.
None of the ideas presented in this article are meant to be taken as investment or trading advice. This content is informational and educational. Please consult with your financial advisor to ensure any ideas that you may consider trading or investing based off of suit your risk preferences, goals, and that you feel comfortable managing such positions. For more information please read our Disclaimer and the attached Terms of Use.