[Chart Of The Week] The Best Market Neutral Trade In the U.S.

JC Parets
April 8, 2016

We've had a heck of a rally in stocks over since late January, led by emerging markets, energy and metal stocks. Starting in mid-February the U.S. and other developed nations got the memo and started to play catch-up. We couldn't be happier with the performance of the stock market since then. But over the past couple of weeks all of our upside targets have been hit; all of the U.S. Indexes and sectors and about 90% of global indexes. So I've therefore been pretty neutral towards stocks since late last month, but I finally turned more bearish earlier this week.

Here is a market neutral trade that I think is definitely worth paying attention to. Whether you're bullish or bearish, this breakout is not something we should ignore:

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Part of the reason why it's hard for me to be bullish the overall stock market is the dramatic underperformance of the financial sector, in both the U.S. and Europe. It's hard, if not impossible for the market to rally without the participation of Financials. Go back and look at the data. Bull markets without financials participating don't happen. Meanwhile, the strength in Technology has been incredibly impressive. I think there's definitely a trade there.

This is a chart of the U.S. Technology Sector vs the U.S. Financial Sector $XLK/$XLF. Notice how this monster consolidation goes back to early March 2009. We are currently breaking out above the downtrend from those 2009 highs and I believe heading a lot higher:

xlk xlf d

For every dollar we are long Technology $XLK we want to be short a dollar of Financials $XLF. We only want to be long this ratio if we're above the upper of these two converging trendlines.

Here is a longer-term chart to see just how much upside we can have in this pair. Because of market inflows and institutional holdings, it is clear that this ratio tends to trend for a long time. This looks to me like a brand new uptrend:

xlk xlf w

This is a theme that I believe is here to stay regardless of whether the S&P500 rallies to new highs or crashes to new multi-year lows. I believe the higher likelihood is the latter of the two outcomes, but regardless, this trade is market neutral. I love that.

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Tags: $XLF $KRE $XLK $QQQ

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