A Powerful Rotation Tests Defensive-Minded Traders: Taking Stock

(Bloomberg) -- The path of least resistance appears to be higher for global stock markets.

S&P 500 futures are holding onto their gains, shrugging off a pair of Trump trade tweets ahead of the NATO summit in Brussels; note that we peaked at ~2,798 last night, the second that the Kavanaugh SCOTUS pick was reported out. Positive NFIB small business optimism figures and PepsiCo results (PEP up ~2% so far) are helping keep things in the green, though we’ll see if this holds given the curious move not to boost yearly outlook despite a 9c beat.

All eyes are on PEP’s 7:45am call for further commentary on what the beverage behemoth is seeing, and how that might impact trading in the consumer staples today. Note that the XLP has been on a nice recovery course since the end of May.

Europe’s Stoxx 600 is on a six-day run and now testing its 200-day moving average, even with a mixed bag of eco data out of the UK, a miss on the German ZEW survey, and the world’s largest derivatives brokers in TP ICAP plunging ~35% in London after ousting its CEO and warning on profits. Chinese stocks closed higher for a third day in a row for their longest run of gains in over a month.

Dawning of a New Rotation?

The S&P 500 has now rallied 1.7 percent in the two days since the trade war was officially ignited. The lack of any new and legitimate threat on the trade front (the gargantuan tariff figures recently thrown around by the Trump administration are nowhere near being considered credible at this point) and the "Goldilocks"-like impression left by Friday’s well-received jobs report are being cited for the carryover effect in yesterday’s session.

But what may be the most interesting part about the action over the past couple days is the dawning of a new rotation, one that has probably flummoxed many traders who have been preparing for the worst once the first tariffs were imposed on Friday.

I’m talking about the powerful move higher in the financials, especially the banks, and the brutal shellacking on the other end taken by the utilities, or two sectors that have been caught up in the debate over the trajectory of the 10-year yield and the flattening yield curve over the past couple months. Consider that the BKX bank index has risen 3.2% in the past two sessions, or nearly double the performance of the SPX, and just a week removed from a record thirteen-day losing streak in the XLF versus the UTY dropping 2.4% in the same timeframe, and almost right after that index saw ten straight days of gains.

The strength in the banks comes with the Fed stress tests in the rear-view mirror and all eyes on earnings over the next week and a half, where some are even saying that an in-line quarter may be enough to keep things humming for the group (as Goldman analyst Richard Ramsden wrote yesterday). Importantly, it has also coincided with similar upside moves in another beaten-down sector of late in the industrials, and most notably the trade proxies like Caterpillar, Boeing, and Deere, which have all ripped in the range of 2.6% to 3.8% since Friday.

It’s also worth noting that the brief jettisoning out of the utilities runs counter to more cautious calls out there to buy protection or hedge sector exposure into earnings -- like Morgan Stanley’s strategy note from Monday, where Michael Wilson (who had a spot-on call to buy utilities in mid-June) upgraded staples and telecom services on the argument that the time is now for an "aggressive rotation toward defensive sectors."

We may see soon enough which rotation (the defensive one or not) wins out, as it may ultimately depend on whether we finally break through major S&P 500 resistance at ~2,800, a level we’ve failed at thrice since the February meltdown. If we stall at the mark yet again, we could easily see the strength in the financials reverse in a nasty manner, especially if the trio of big banks (JPMorgan, Citi, Wells Fargo) that report at the tail end of this week don’t deliver the goods.

Notes From the Sell Side

The initiations are piling in for one of the hottest tech IPOs in the U.S. this year, Avalara, and no one seems to want to make a big call (5 equivalent holds so far against zero buys or sells) given the scorching hot ~98% run-up versus its mid-June pricing.

BofAML raises its price target on Apple to $230, citing revenue upside from augmented reality, which is very close to being the highest on the Street..

Keybanc slapped a Street-high price target of $38 in the SFIX initiation (~$10 above the Street average for a stock that is already up 64% since the end of May) and downgraded both URBN and JWN in a preference for vendors over retailers..

Stifel lifted its rating on Wynn Resorts to a buy on valuation, which looks to be the first upgrade since shares tanked nearly 20% in the past month and a half.. Mizuho moved CMG to an equivalent sell after that stock’s massive run in the past few months ("currently prices in an aggressive recovery in both comps and margins")..

Baird pulled a similar move on TEX, pitting an underperform rating on the heavy machinery name after a quarterly rental survey suggested equipment demand is likely to slow..

Goldman is cutting estimates on the cruise line stocks (CCL, NCLH, RCL) due to near-term fuel and FX headwinds while Morgan Stanley transferred coverage on the auto dealers, remaining cautious ("prefer to limit our exposure to the cycle") and double downgrading both AN and SAH to underweight while double upgrading KMX to an overweight and upping ABG to an equal-weight..

Tick-by-Tick Guide to Today’s Actionable Events

• Today -- Allen & Co. annual conference in Sun Valley starts today
• Today -- Semicon West begins (day one of three); AMAT CEO will speak
• Today -- Intersolar North America begins (day one of three)
• Today -- Keurig Dr Pepper will start trading on NYSE under symbol "KDP"
• 7:00pm -- SMPL earnings
• 7:45am -- PEP earnings call
• 9:00am -- ESPR analyst day
• 10:00am -- JOLTS job openings
• 10:00am -- IDRA/BCRX shareholder vote on deal
• 10:00am -- MITL shareholder vote on Searchlight deal
• 11:00am -- OCLR shareholder vote on LITE deal
• 11:30am -- JWN investor day
• 12:00pm -- DoE short-term crude/natgas outlook
• 12:30pm -- OTEX investor day
• 1:00pm -- Treasury auction: $33b 3-year notes
• 2:00pm -- World Cup semi-finals: France vs Belgium
• 4:00pm -- BEN monthly sales
• 4:01pm -- AIR earnings
• 4:05pm -- WDFC earnings
• 4:30pm -- API oil inventories
• 5:30pm -- KLIC analyst day
• Tonight -- IPOs expected to price: Mav Beauty Brands (MAV CN)

To contact the reporter on this story: Arie Shapira in New York at ashapira3@bloomberg.net

To contact the editors responsible for this story: Chris Nagi at chrisnagi@bloomberg.net, Steven Fromm

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