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Former global banking executive, now retired and investing part-time.
  • Divergence in Bond vs. Equity Prices 0 comments
    Apr 5, 2009 8:05 PM | about stocks: TBT, LQD, SDS

    Equity prices (+25% in 4 weeks) have priced in much better economic environment and corporate default expectation than corporate bond market. Meanwhile, quantitative easing and unwinding of "fear trade" are finally leading to increase in treasury yield.  I'm using the following three-leg trade:  long TBT, long LQD, and long SDS (short SPY).  My reasoning is that one of three scenarios is likely to happen:

    1.  Fed is successful in reflating the economy and business environment does improve -- higher interest rates and lower credit spread will benefit TBT and LQD; SDS might suffer.

    2. Credit spread remains high despite Fed's efforts and deflation continues -- SDS will benefit as current equity prices have priced in improved economy and corporate earnings; TBT and LQD will suffer.

    3. Fed somehow gets economic growth without driving up inflation -- LQD will benefit, but TBT and SDS will suffer.

    Depending on each person's assessment of the probability of the three scenarios above, one can assign weights to the three positions.  I'm using ratio of 3 TBT : 3 LQD : 1 SDS as my baseline portfolio, and adjusting the weights as market condition evolve. 

    Happy to hear suggestions on how to play the current macro-enviroment will so many variables happening at the same time, and many cross-currents affecting daily market movement. 


    Stocks: TBT, LQD, SDS
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