Debate Rages Over Which Sector Rotation Wins Out: Taking Stock

(Bloomberg) -- Traders were already skittish going into the latest tariff announcement, with the main U.S. indices all closing at the lows, and the mood soured immediately last night (S&P 500 futures broke down another twelve handles) after the statement made it into the public sphere.

But we’re waking up to nothing but green today, with the e-minis up around five handles despite the disappointments in the trade salvo, like the part about the tariff rate jumping to 25% at the turn of the year, or the threat of additional tariffs on $267 billion of goods if China retaliates, which it is wont to do in the shape of levies on $60 billion if past statements turn to reality.

Add a double batch of weak earnings reports, with FedEx falling ~3% last night on a big bottom line miss and Oracle off nearly 4% on a top line whiff, and it’s all the more puzzling why the markets are looking higher to start the day.

So what gives?

Well, for one, it’s possible that a lot of these disappointments were baked in given the weakness in Monday’s session (S&P 500 had its worst day in over a month). It’s also possible that the strength overseas, with the Shanghai Composite surprising to the upside by almost 2% and the Nikkei up 1.4%, giving the dip buyers in the States comfort in doing what has worked for nine-plus years at this point, which is just to load up on any weakness and watch the money pile up.

One thing that’s for sure is that the debate over whether to allocate portfolios more defensively will be heating up on Wall Street.

So Which Rotation Wins Out?

Despite the early gains, the whole thing reeks of a lengthier-than-expected trade war that has little to show for it in the way of progress towards a solution.

This could make for a more sticky risk-off trade and a stronger rotation into the more defensive sectors in the market (like utilities, REITs, consumer staples) out of tech, or similar to what we saw in the beginning of the month before being partially unwound last week.

We saw some of this take shape in Monday’s session, as the FAANGs were exceptionally weak the minute the opening bell rang (Netflix and Amazon both finished the day down >3%) as were the semiconductors. Even Apple couldn’t sustain a modicum of a bid after our early afternoon scoop said that the next round of tariffs would exclude the Apple Watch and AirPods.

Debate Rages Over Which Sector Rotation Wins Out: Taking Stock

Meanwhile, the REITs, consumer staples and utilities all ended in the green and were the top-performing sectors in the S&P 500. Don’t be surprised if this is the new norm, at least for the near term, if the dip-buying that we’ve seen so far (like the pre-market bounce in tech names AMD +2.1%, Micron +1.1%, Netflix +1.4%) subsides at any point during the next few days.

That’s especially true for the tech space, as the "Long FAANG+BAT" trade remains a very popular one (most crowded trade for the eighth straight month, according to BofAML’s September fund manager survey), so pain could be on the table for the bulls if sentiment truly does turn bearish.

What’s the Trade?

Aside from the must-watch rotation debate between defensives and tech, the sectors to focus on today include the homebuilders ahead of the 10am data (recall the group took a brief hit last week on a cautious survey from Zelman), the rails after Union Pacific (+2.1%) unveiled a new plan to achieve its long-term operating ratio target, auto retailers and suppliers after AutoZone and BorgWarner are looking at rough days thanks to their respective results, jewelry stocks on potential private equity interest in Denmark’s Pandora A/S (+7% in Copenhagen), and energy stocks with Crude climbing to day’s highs after Saudi Arabia said its comfortable with Brent above $80/barrel.

Lastly, your long read of the day comes courtesy of Institutional Investor, who profiled short seller Jim Chanos, founder of Kynikos Associates, in a piece titled: "How Jim Chanos Uses Cynicism, Chutzpah — and a Secret Twitter Account — to Take on Markets (and Elon Musk)."

Notes From the Sell Side

The Street is gushing over Union Pacific’s new "Unified Plan 2020," with Bernstein saying that "the market is going to want to buy this news" while Citi now sees shares moving towards the $180-$200 range (versus its last close at $156.71) in the intermediate-term. Citi adds that the move could push Norfolk Southern to adopt the strategy, which would be a big positive to the stock as well as a negative for JB Hunt.

UBS says Tesla wins "another lap" on the topic of electric vehicle competition as Audi’s new E-tron SUV fails to set new benchmarks in the premium EV segment. This dovetails nicely with Bernstein’s note from Monday, where they said that Tesla faces limited competition from legacy automakers for at least the next two years, with "no credible competition" for the new Model 3 until 2020.

JPMorgan is downgrading Red Hat ahead of Wednesday’s earnings as headwinds (middleware deceleration and softer renewals pattern) are likely to linger for a few quarters; the bank expects shares to trade in a $120-$180 range until these headwinds normalize.

Morgan Stanley says the outlook is darkening for midcap banks given weaker loan growth and a more muted 3Q rate environment. The firm is slashing EPS estimates for most banks and downgrading BankUnited to an equal-weight on loan growth and NIM concerns.

Bearish calls are out there on Discovery (Pivotal cuts to a sell as fundamentals haven’t meaningfully changed despite the ~20% surge in the past month), Workiva (Morgan Stanley downgrades to underweight as "blue skies" scenario are already priced in), and Primerica (Citi drops to a sell as the stock’s rising P/E premium is at odds with a growth slowdown).

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

  • Today -- BABA investor day (day two of two)
  • Today -- RAVN investor day
  • 7:00am -- GIS earnings
  • 8:00am -- CBRL earnings
  • 8:00am -- BRO investor day
  • 8:30am -- GIS earnings call
  • 9:00am -- DVMT analyst meeting
  • 10:00am -- NAHB Housing Market Index
  • 10:00am -- AZO earnings call
  • 11:00am -- BWA, DHR investor days
  • Post-market -- MSFT expected to boost dividend by 10%-15%, according to Stifel
  • 4:00pm -- TIC Flows
  • 4:00pm -- MB analyst day
  • 4:30pm -- API oil inventories
  • 10:00pm -- WWE Mixed Match Challenge returns on Facebook Watch
  • Tonight -- IPOs scheduled to price: X Financial (XYF)

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