A Leader/Laggard Long/Short ETF Pair Trade

With the benefit of hindsight (and returns data), it is now safe to say investors that were long biotechnology stocks or exchange traded funds at the start of the year while being short or out of consumer staples equivalents are not smiling.

Not with the SPDR S&P Biotech ETF XBI, the third-largest biotech ETF by assets, down almost 18 percent while the Consumer Staples Select Sector SPDR XLP is up 6.4 percent year-to-date. A scenario where being down 18 percent in an ultra-volatile ETF like XBI while missing out on an easy 6 percent-plus with the low beta XLP does not sound fun.

As was noted in this space Wednesday, there are inklings biotech ETFs are primed for a bounce. XBI may have gotten the ball rolling with a gain of more than seven percent yesterday. That means the Direxion Daily S&P Biotech Bull Shares LABU, which we endorsed here yesterday, surged 22.5 percent. LABU is the triple-leveraged answer to XBI.

More importantly, members of the professional community see opportunity in being long biotech with a short staples kicker. In a note out Wednesday, Rareview Macro founder Neil Azous recommends a long XBI/short XLP trade. Azous points out that a ratio comparison of XBI and XLP yields a rare, but often efficacious rectangle chart pattern.

“XBI/XLP was coiling for 9-weeks and the release, now that it is to the upside, should be greater than the range technically,” he said in the note. “On that basis, the reward-to-risk ratio is greater than 2 to 1 based on where we have identified our stop-loss level on the ratio –1.003.”

As we pointed out Wednesday, there are signs traders are targeting LABU, XBI's leveraged counterpart, with data confirming as much.

For example, for the five-day period ended April 5, LABU's volume was more than 29 percent above the trailing 20-day average. Additionally, LABU has averaged daily inflows of nearly $158,000 over the past 30 days, according to Direxion data.

As Azous points out, data also suggest investors are rotating out of defensive sectors, such as staples and utilities, relative to the S&P 500.

“Healthcare has never been this cheap relative to Staples on forward earnings. The valuation gap should narrow over the next six months in a weakening earnings environment on account of Healthcare having a higher long-term earnings growth rate than Staples,” he said.