In May, I brought up an odd trade idea here on InvestorPlace – one that would require taking a short position. This article — Bet Against Tech Stocks with This Bold, Lower-Risk Trade Idea — was unusual for me. I’m generally very against making a directional bet on stocks or broader markets. But in this case I called it one of the most interesting contrarian trades today. That trade? Going long on regional banks and shorting tech.
At the time it seemed like a crazy pairs trade. However, the action in small-caps (the category into which many regional banks fit) is potentially the catalyst of what could be a very early move in the relative performance of these two sectors.
As a refresher, the idea of a long/short spread trade is to exploit the relative performance of two sectors or asset classes to each other. You’re dollar for dollar short and long, which effectively neutralizes the market’s beta. You’re making a pure return stream just on your long position being up more or down less than your short position. A key factor to note is this bet is NOT dependent on the overall stock market’s direction — only the relative spread.
Why This Contrarian Trade Now?
For the better part of a year and a half, many active managers have been shorting small-cap stocks and going long on large-cap tech. It clearly worked. Large-cap tech drove market averages higher, while small-caps languished, particularly diverging just as the regional banking crisis of last year was playing out. Here we are now over a year past that. Small-caps have had a monster surge against large-caps, and now tech is taking it on the chin. How does the ratio look? To put it simply: very early in its uptrend.
What would cause this to push higher, so that tech underperforms regional banks? Probably heightened stock market volatility. Why? Because if markets get more volatile, the first thing investors will sell are their biggest winners. Guess what folks? Those ain’t the regional banks. The biggest winners are the top 10 large-cap tech names that have driven the bull market in the S&P 500 and caused a “concentration bubble” as a result. If that concentration bubble has begun to burst, then there’s a lot of room for regional banks to outperform tech. That would mean this trade can make money whether the broader markets push higher or lower in absolute terms.
We are in a new cycle, and things are changing. A tectonic shift in the relationship between small-caps and large-caps might be taking place, and this could be a creative way to play it for many months to come.
On the date of publication, Michael Gayed did not hold (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
On the date of publication, the responsible editor did not have (either directly or indirectly) any positions in the securities mentioned in this article.
