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There’s an old boxing adage that says “a good big ’un will always beat a good little ’un.” This principle packs as much of a punch in the Square Mile as it does in the ring. When the stock market is on the ropes, the heavyweights of the FTSE 100 tend to get the better of the middleweights of the FTSE 250. During the worst of the equity drubbings of 1998, 2002, and 2008, the FTSE 100 beat its punier rival by more than 20 per cent each time.
One reason for the FTSE 100’s knockout performances versus the FTSE 250 during times of fear may be the types of company that make up the two indices. The mid-cap index contains many economically-sensitive businesses that derive more of their earnings from the UK. By contrast, its large-cap rival is dominated by multinationals, whose risks are spread more widely. Also, the superior liquidity of FTSE 100 shares also makes them a safer haven during panics.
Lately, the large-cap index has again landed some deft blows. Between early June and late August, it outperformed the mid-cap index by almost 7 per cent. Should the UK stock market be in for more of a hiding in the months ahead – as I suspect it may – the FTSE 100 could put its rival on the canvas. To profit from this scenario, it would be necessary to take a long position in the FTSE 100 and a short position in the FTSE 250.
History suggests some of the best moments at which to do this would be where the ratio of the two indices’ prices retreats to below its 21-week exponential moving average (EMA) and then bounces back above it. A major objective is for the ratio to get back to its 200-week EMA, implying relative gains of around 8 per cent from current levels.
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