Ever since my friend “Mr. Bull” gave me a ribbing over writing a bearish piece on Intel (INTC) the day before a strong one-day rally, we have used Intel as a metaphor for whether the bulls or the bears are in control of the market. For the five weeks since then, INTC has gone nearly straight down while the general market has generally stabilized. This divergence likely motivated him to ask recently whether it made sense to do a pairs trade between Microsoft (MSFT) and Intel.
I initially dismissed the idea because MSFT tends to be a slow-moving stock and semiconductor stocks have recently had very poor performance relative to tech. After having a chance to review the charts, my opinion has become a bit more nuanced.
First, the relationship (ratio) between the NASDAQ and the Philadelphia Semiconductor index (SOX) has bounced in a 20% trading range since the beginning of 2008, excluding the market collapse in the Fall of 2008. The recent out-performance of the NASDAQ has driven the ratio to the top of this range. If history holds, this ratio should reverse with the semis increasing faster than tech in general (semis relief rally) or tech in general falling faster than semis (tech correction).
My guess is to bet on some reversion to the mean for this ratio. Since the ratio got to its highs on a divergence in trading direction, this guess would lead to a bet long on the semis along with a short on tech in general.
This opinion is relevant for the MSFT vs INTC pairs trade because it suggests going long INTC versus a short of MSFT for the pairs trade. The ratio of the two stocks is bouncing off recent lows that marked the climax of a steep downtrend in place since last Fall. It is interesting to note that the lows in this ratio have marked the end of general market corrections that were underway at the time. So, if INTC begins to out-perform MSFT, it will likely occur amidst general market weakness. Imminent market weakness is consistent with the technicals I outlined last week. So, if I were to execute this pairs trade, I would be inclined to overweight the MSFT short position versus the long INTC.
Source for all charts: Stockcharts.com
Be careful out there!
Full disclosure: no positions