Exploring Relationships, Correlations, and the Power of Percentages

Tinker & Trade Weekly Edition 2: Exploring Relationships, Correlations, and the Power of Percentages

Hello Tinkerers, Explorers, and Market Alchemists,

Welcome back to Tinker & Trade Weekly! Last week, we began our journey by combining Bollinger Bands with volume-weighted averages, and we tinkered with the basics to uncover a new alchemical twist. Today, we take a step further into the unknown—not just tinkering with individual signals, but exploring the hidden relationships between assets. We’re diving deep into daily percentage movements, correlations, and the fascinating alchemy that happens when seemingly simple datasets start telling a bigger story.

Imagine this: you’re standing in the center of a vast market square—the voices of traders, investors, and speculators echo all around. It’s a place where numbers dance, relationships form, and where small movements ripple outward to impact the whole crowd. Today, we’re dissecting that market square, focusing our attention on a special corner—the pharmaceutical ETFs of the Life Sciences & Healthcare (LSHC) sector. These ETFs represent not just companies but innovation, hope, and the very pulse of an industry that directly impacts our well-being.

The Experiment

This week, I had an idea: What if we compare the LSHC ETFs based on daily percentage movements rather than their absolute prices? After all, sometimes the true character of an asset isn’t in how high it climbs or how low it falls—but in how it moves day by day. By focusing on percentage changes, we can strip away the distraction of raw price levels and see how each ETF—whether a behemoth like VHT or a nimble contender like XPH—**stacks up on a level playing field**. The game changes when we look at the rate of movement, not just the numbers.

This approach is actually a favorite among arbitrage traders. They’re the ones who watch for those subtle discrepancies between assets that theoretically should move in tandem. And even though I’m not here to bore you with complex trading tactics (okay, maybe just a little), there’s something to be said about how looking at daily percentage movements can help uncover the hidden rhythm—the pulse—of the market. It's like peeling back the layers of the market to see what lies beneath—a deep dive into the unseen forces that drive prices, correlations, and opportunities.

Pharmaceutical ETFs in the Spotlight

Let's take a closer look at the key players in this analysis:

• VanEck Pharmaceutical ETF (PPH): Focused on the largest global pharmaceutical companies, providing a snapshot of the industry's giants.
• iShares U.S. Pharmaceuticals ETF (IHE): Targeting U.S.-based pharmaceutical manufacturers, giving us insight into the American market's performance.
• SPDR S&P Pharmaceuticals ETF (XPH): An equally weighted ETF that brings a different flavor—offering exposure to mid-sized companies, sometimes with more growth potential.
• Invesco Dynamic Pharmaceuticals ETF (PJP): Emphasizing a dynamic strategy by selecting stocks based on several investment merit criteria, making it a more actively managed play.
• First Trust Nasdaq Pharmaceuticals ETF (FTXH): Focuses on smart-beta selection, blending traditional pharma with a twist of innovation.
• Vanguard Health Care Index Fund ETF (VHT): A broader healthcare ETF that includes pharmaceuticals, biotech, and healthcare providers, providing a well-rounded perspective on the sector.

Each of these ETFs brings something unique to the table, and by comparing their daily percentage movements, we aim to understand how they perform not just individually but in relation to one another.

Daily Movements & Correlations For this analysis, we decided to break it up into different time frames: 5 days, 1 month, 3 months, and 6 months. We plotted daily percentage changes for each ETF—a visualization that makes it easy to see which ETFs were more volatile and which remained more consistent over different periods. It’s not just about seeing which ETF went up or down; it’s about understanding the patterns of movement—how they twist and turn through the ebbs and flows of market sentiment.

To add to the magic, we generated a correlation heatmap for each time frame. Correlation values can range from -1 to +1:

• +1 means perfect positive correlation: assets move in the same direction together, almost like synchronized dancers.
• -1 means perfect negative correlation: assets move in exactly opposite directions, as if one rises while the other falls.
• 0 means no correlation: their movements don’t show any particular pattern, suggesting independent behaviors.

Why is this insightful? Because correlations help us see whether the ETFs are diversifying or if they are all essentially moving as one. High correlations mean they’re likely tracking similar forces, while low correlations could mean they’re reacting to different drivers. It’s like understanding which players on a sports team are working in harmony and which are pursuing their own strategies.

What Did We Find?

1. Relationships Revealed

The correlation heatmaps are like the dance floor of the market square—they reveal which ETFs like to dance together, and which prefer to go their own way. Surprisingly, there were moments of decoupling during periods of market turbulence—times when the usually tight-knit pharma ETFs diverged, suggesting opportunities for diversification or even arbitrage. For instance, when macroeconomic news affected one part of the healthcare industry more than another, we saw some ETFs pulling away from the pack. This decoupling can be a signal for investors seeking diversification or a potential chance for arbitrage traders to capitalize on differences.

2. Volatility Unearthed

The daily percentage movement charts provided another layer of insight: they showed the periods when volatility was more pronounced. For instance, XPH seemed to be more sensitive to market news, whereas VHT moved with more stability, perhaps reflecting its broader healthcare exposure rather than being strictly pharmaceutical-focused. These differences in volatility tell us more about the risk profile of each ETF—**XPH** might offer greater returns during a bullish market, but it also comes with increased risk. On the other hand, VHT seems like a steadier option, which could be suitable for those looking to balance their exposure within the healthcare sector.

3. Arbitrage Opportunities

As we monitored the changes, there were periods when correlations broke—these could be signs of mispricing or temporary dislocations. Arbitrage traders might view such moments as opportunities: buy the underperforming ETF and sell the outperformer, expecting them to return to their typical pattern of movement. This kind of strategy requires a keen eye and quick reflexes, but the potential rewards can be significant. Imagine a moment when PPH and IHE, usually closely correlated, suddenly diverge—one falls while the other rises. That could be an arbitrage opportunity in the making, provided you have the insight and agility to act on it.

So, Why Does This Matter?

This analysis is more than just numbers and graphs—it's about telling a story. The story of how assets move, how they are connected, and how we can use those connections (or lack thereof) to our advantage. In the world of financial alchemy, turning raw data into insights is like combining elements to create something valuable. Sometimes the real magic lies in those relationships—in the dance between assets—and understanding those dynamics can help you position yourself, not just for the next big move, but for the long-term journey. By understanding which assets move together, you can better balance your portfolio, mitigate risk, or even identify opportunities others might miss.

A Thought to Ponder

How do you view correlations in your investments? Do you prefer assets that move together, or do you try to diversify and find relationships that balance each other out? Sometimes, in the pursuit of alchemical gold, the power lies not just in what we hold—but in how those holdings interact. What combinations of assets could create your next golden insight? Perhaps you have a mix of volatile and stable assets—does understanding their correlation give you more confidence in your strategy? Or does it inspire you to rethink how they might work together more effectively?

Let’s Tinker Together

Thank you for being part of this journey. We’re not just investors; we’re explorers, tinkerers, and alchemists. This week, I encourage you to take a look at the assets you hold and ask: What are the hidden relationships that drive them? Could a deeper understanding of those connections unlock a new insight? Sometimes the greatest insights come not from the obvious, but from those subtle connections that lie beneath the surface—waiting to be uncovered by those willing to tinker.

Until next time, stay curious, stay bold, and keep tinkering.

—--

Alexander Naudé

The Tinkerer & Market Alchemist

P.S. What are you curious about? Drop me a message—I’d love to hear your ideas and shape the next adventure together.