A couple weeks ago I was fairly adamant about the fact that rising rates, in a slow U.S. corporate earnings growth environment, with the backdrop of weakening global demand would serve as the sort of tri-fecta of headwinds for U.S. equities, despite what appears to be marginally better economic data on our shores. Since the May 22nd all time highs in the SPX, the index saw a 7.5% peak to trough sell off and has since bounced about 5% from the June 24th intra-day lows, placing the index just about 2.5% from the all time highs.
I believe that we may have put in the highs for the year, despite the fact that a test of 1650 seems pretty likely at this point, but just a tad higher could be a fairly opportune spot to lay out some trading shorts. While we remain short in our own trading, it is important to note that we made some covers of bearish positions on weakness and or spread some outright put positions thus lowering our break-evens in late June (here). That being said we might have been a little early laying out some new shorts, but we believe tops are processes, not a point in time. The next few weeks of Q2 earnings will likely dictate the course of equities for the balance of the quarter and timing of entry will be one of the most critical components of trading success for those looking to be a tad contrarian on this rally.
Last week (until Friday’s low volume close rally) I was encouraged by the SPX’s inability to close above its 50 day moving average which had served as crucial support for most of the year. Today’s gap opening is fairly impressive, but a failure here and close back towards support would encourage me to hold onto some shorts where I have identifiable catalysts, and possibly lay some new ones out.
I want to quickly hit on a sector that we have traded sparingly in 2013 given a whole host of factors, none more prominent than their Q1 out-performance, banks. The sector is becoming a little bifurcated of late, and not all trade well, with GS & MS down about 10% from their 52 week highs, while JPM and WFC have traded in lock step with the SPX.
The only position that I currently have on in the sector is long a July out of the money XLF put spread that I legged into over the last couple weeks (here). So why are we starting to look at the banks now? With interest rates rising there has been plenty of debate regarding which banks will see the benefits from net interest margins rising, and which will be hurt by the potential for slower loan growth or some combination of the two. We will take a deeper dive on the topic as we get some of the second half guidance from U.S. banks over the next couple weeks, and look to place our bets in what we think will be the winners or losers in what could be a new higher rate environment for bank stocks over the next few years, at least here in the U.S. For the moment it appears the “investment banks” like GS & MS as opposed to the “money-center banks” like JPM & WFC have underperformed off of the June 24th lows in the SPX, and frankly act very tired in front of their July 16th & 19th respective Q2 earnings releases.
Could GS & MS be on the losing end of some currency, commodity, rate or credit trades that went haywire in the nearly unprecedented price action in global macro markets of the last 3 months? And if so would these 2 investment banks be more vulnerable to losses given the relative small size of their balance sheets compared to their money-center banking peers? Remember just a few weeks ago a research firm suggested that Citi could be looking at a $5 to $7 billion hit from their positioning in dollar/yen, which could be the reason that Citi has lagged JPM and WFC over the last couple weeks.
Meanwhile, the regional banks have been much stronger, with KRE making a new bull market high last week. They are in the bread and butter business of boring banking, where they borrow short and lend long. In that sense, investors are getting optimistic that the rise in interest rates might finally give their earnings power a boost in the quarters to come.
Potential Earnings Trades – Put Calendars -If GS & MS can’t rally into next weeks earnings we may look to sell weekly near the money puts to buy Aug or Septs. Stay tuned.