Pair's Trades to Initiate

We look to take a pragmatic value approach towards our pair’s trading portfolio. The two sectors that look appealing to us are the packaged food and consumer durables & apparel industries.

Packaged Food

The chart below shows our fair valuation model for the industry. To derive this figure, we compute the earnings, book value and free cash flow yield for the aggregated industry and weight them according to historical pricing correlation. When the trend is higher, then we consider the industry “investable”. Clearly the fair value trend is rising over a longer period of time. There has been a recent dip in the fair value trend that we will watch closely.

We also find that the earnings, book value and free cash flow upward trend remains intact. That is an important consideration.

We find the value variance between the industry price and its fair value expressed as a z-score. Typically, when this model drops below -1.0 standard deviations the industry has offered us excellent trading opportunities.

We also note that the second derivative rate of change often confirms the trading opportunity. Both the value variance and the rate of change figures are signaling a buy for this industry that has an up trending fundamental picture.

On the daily chart the industry has bounced off the 38.2% Fibonacci retracement support from the February lows, it has retaken its 20DMA and both RSI and MACD are showing improving momentum.

On the daily relative rotation graph the packaged food industry has moved from a lagging to an improving industry relative to the SPX.

Taking into account there is no actively traded packaged food industry ETF, we will purchase the individual components in the industry weighted appropriately to mimic the movement of the index.

Long USDJFO / Short XLP

Our relative price performance z-score shows a large divergence between the packaged food industry and the overall consumer staples sector. We will trade this as a pair’s in anticipation of a closing of the gap.

Consumer Durables & Apparel

The fair value and fundamental picture remains in an uptrend.

The value variance model is signaling a buy.

The rate of change is confirming the buy signal.

On the relative rotation graph we are finding the industry is still in the lagging category relative to the SPX but it is moving towards the improving quadrant. We will be monitoring this closely for improvement.

On the daily chart we would like to see the marked support level hold and a bullish MACD cross. We are also seeing a bullish divergence between the index price and the RSI.

On the weekly chart we are sitting at support on the marked ascending wedge. We will keep our stops tight should this pattern fail. Given the fundamental picture, we believe the industry is due for a bounce from these levels. A break through the 320 level could launch this industry much higher.

Taking into account there is no actively traded consumer durables & apparel industry ETF, we will purchase the individual components in the industry weighted appropriately to mimic the movement of the index.

Long GSPLP (S5COND on Bloomberg) / Short XLY

The relative price performance z-score is showing an extreme level of mispricing between the industry and the sector.

Joseph S. Kalinowski, CFA

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This analysis should not be considered investment advice and may not be suitable for the readers’ portfolio. This analysis has been written without consideration to the readers’ risk and return profile nor has the readers’ liquidity needs, time horizon, tax circumstances or unique preferences been taken into account. Any purchase or sale activity in any securities or other instrument should be based upon the readers’ own analysis and conclusions. Past performance is not indicative of future results.