Alpha through equity-versus-FX trading
Cross-asset relative value
Equity and currency markets respond to macroeconomic news at different speeds and with different sensitivities. Terms-of-trade shocks, for example, tend to be reflected in FX markets within days, while their effect on corporate earnings and equity valuations unfolds over weeks or months. This temporal divergence creates a persistent opportunity for relative value strategies.
Our approach constructs paired positions: long equity exposure in a country paired with a short position in its currency (or vice versa), based on macroeconomic signals that predict the relative performance of the two asset classes.
Signal construction
We identify three categories of macro signals that predict equity-FX divergence: real effective exchange rate misalignment, relative growth momentum, and commodity terms-of-trade shifts. Each signal is constructed from point-in-time JPMaQS data and has a clear economic rationale for why it should affect equities and currencies differently.
The composite signal is formed by equal-weighting the three components after individual normalization. Positions are rebalanced monthly with transaction cost adjustments for both equity and FX legs of each trade.
Performance analysis
The equity-versus-FX strategy generates a Sharpe ratio of 0.61 after estimated transaction costs, with a maximum drawdown of 8.2% over the 12-year evaluation period. The strategy's returns have near-zero correlation with standalone equity, FX carry, and FX momentum factors, making it a valuable diversifier within a multi-strategy portfolio.
Country-level decomposition shows that the strongest signals come from commodity-exporting economies, where terms-of-trade dynamics create the largest wedge between equity and currency performance.
Conclusion
Pairing equity and FX positions based on macro fundamentals offers a structurally differentiated source of alpha. The strategy exploits the inherent speed-of-adjustment differences across asset classes, a feature that is unlikely to be arbitraged away due to institutional segmentation between equity and currency markets.