The Standard & Poor’s 500, closing at 2015 on October 9, is within spitting distance of the 2020 level that marked the high point before a hefty decline ended the August and September rallies.
With early results from earnings season at Monsanto (MON), Yum! Brands YUM), and now Alcoa (AA) all falling disappointingly short of Wall Street expectations, there’s good reason to think that third quarter earnings will result in another retreat from the highs.
On the plus side, none of these three stocks are the kind of bellwether stocks that determine the tone of the entire market. Alcoa, which was once an industrial stock to conjure with, isn’t very good at predicting the course of the entire market anymore.
On the down side, some of the trends even in these early returns are exactly the sort that should worry the overall market. Monsanto disappointed on weakness in developing economies; Yum and Alcoa showed slower than expected growth in China. Alcoa downgraded its estimates for China and now predicts a 22% to 24% drop in demand for aluminum for the manufacture of heavy trucks in China. That’s especially important because, Zack’s points out, a decline in truck production has often preceded recession in China.
There is some hope in Alcoa’s guidance, though.The company sees the current surplus in aluminum switching to a deficit in 2016 as global aluminum demand grows by 6.5% in 2015. Aluminum prices are down 40% from their peak in 2011 and down 11% this year.
Not everyone agrees with Alcoa. Morgan Stanley, for example, sees aluminum remaining in surplus in 2016 and Bloomberg sys the glut might even get worse as capacity grows in China.
And there we have the make or break question for this rally. So far commodities and emerging market stocks have moved up on a weak dollar, and speculation that we’re about to see the end of a supply glut in oil, iron ore, copper, and aluminum among other commodities. Speculation was enough while stocks drove toward the old highs, but now that we’re at those highs I think investors are going to need some evidence that the supply/demand balance is about to shift in producers’ favor.
Freeport McMoRan Copper and Gold (FCX) is a prime example of this shift in dynamic. As of the close on October 9, the shares were up 51% from the September 28 low. But with the stock up 50%, investors and traders are looking for some evidence of a sustainable recovery. Shares of Freeport McMoRan copper up just 0.22% at the close on Friday. Alcoa’s shares were down 6.81% on its earnings news. Freeport McMoRan reports earnings on October 22. Think we might see some profit taking before that report?
Spread that profit-taking across the market and you’re looking at an end to the current rally.
Yesterday I posted that Monsanto’s (MON) ugly earnings report provided important guidance for navigating earnings season. Wall Street analysts are projecting a 6.9% drop in third quarter earnings but that decline won’t be spread evenly across all market sectors. Energy stocks will, of course, see a big drop in earnings but, according to Standard & Poor’s, sectors such as telecommunications, technology, consumer discretionary, and health care will see growth of 10% or better.
Now we get a further bit of navigational advice from Yum! Brands (YUM). On Tuesday, after the market close, Yum! Brands reported earnings of $1 a share, 7 cents lower than Wall Street estimates, and revenue of $3.43 billion instead of the projected $3.67 billion.
But what is important for navigating this quarter’s earnings season was the market reaction to this miss.
Companies miss earnings projections by 7 cents or about 6.5% all the time. It’s never good news.
But seldom do stocks get taken out and shot for a 6.5% miss.
And that’d exactly what the market did to Yum! Brands. The shares closed at $83.42 on Tuesday before the earnings report and then plunged Wednesday after the open to $68.09 as of 10 a.m. New York time. That’s a drop of 18.5%.
Now there’s no doubt that Yum! Brands disappointed pretty much across the board. Same store sales in China, which accounts for about one-third of Yum’s operating profit, grew by just 2% instead of the projected 9%.
But Yum! Brands real offense was disappointing the market in some of the places where the market is most susceptible to fear.
Financial markets are worried about slowing growth in China? Yum’s results raised the possibility that growth in China had slowed so much that the company’s revenue would never completely bounce back from the food-safety scandals that had devastated sales. With growth in China slowing, what if Yum’s food safety scandals had destroyed the brand with Chinese consumers? Forever!
The other fear that hit Yum like a cold burger patty in the face was worry that growth in the fast food sector was over Forever! McDonald’s (MCD) revenue line has been essentially flat for four years. The sector is battling perceptions that its customers have moved on to better quality food and are looking for something other than gray burgers and overly salty chicken. What if the sector is never coming back?
Never is a long time and it’s a good bet that the fears about the future of Yum sales in China and about the death of the fast food sector are somewhat overblown. That’s what happens in a panic.
But the larger point for investors during this earnings season is that the markets are littered with land mines that are just ready to blow up on any company that steps on one. China growth slowdown is obviously one such land mine and Yum! Brands won’t be the last company to trip that mine this quarter. Falling commodity prices make up another mine—I’d look out, especially, for oil, copper and iron ore. The strong dollar is a third—look for exporters that live up to fears that a strong dollar will decimate sales. I’m sure there are others—falling prices in the drug sector as a result of political and regulatory scrutiny, for example. I’m sure you can make up your own list of land mines and the companies most likely to step on them.
YUM! Brands (YUM) is moving back toward normal in China, according to second quarter earnings announced after the market close today.
But is “normal” enough for a stock that’s trading—even while the China problem continues to hurt sales—near an all-time high?
At the end of 2012 sales at YUM! Brand’s KFC stores in China fell off a cliff when government officials discovered that some suppliers had fed their chicken more antibiotics than permitted under Chinese rules. By April 2013 sales were down 29% from April 2012.
In the months since sales have clawed their way back toward normal. In May sales were down just 19% from May 2012. In June, the company announced today, the decline had been trimmed to just 10% year to year. And, the company continued, by the fourth quarter of 2013 growth in China will have turned positive.
For the second quarter the company announced earnings of 56 cents a share, two cents a share better than Wall Street projections. Sales came in at $2.9 billion, slightly short of the $2.93 billion consensus, and an 8.3% drop from the second quarter of 2012.
What’s hard to tell from these results—and what has been hard to tell about YUM! Brands ever since the hatching of the China chicken disaster—is what is the underlying growth trend for YUM! Brands. Before the huge drop in sales in China overwhelmed all the other numbers from the company, YUM! Brands was showing strength on a turnaround at its Taco Bell stores.
But the company faced important questions about future growth. Read more
You and I aren’t Warren Buffett. And that means we aren’t going to get the kind of deals that Buffett gets.
Nobody is offering you or me preferred stock yielding 9% in a safe consumer Blue Chip like that Buffett got as part of last week’s $23 billion ($28 billion if you include assumed debt) buyout of HJ Heinz (HNZ.) To get 9%, you have to be Warren Buffett, Sage of Omaha, with a name that brings investment bankers flocking to finance any deal that includes you. (Part of Buffett’s profit from a deal like Heinz is in essence a fee from making the financing of a $28 billion deal easier for his other partners.)
But that doesn’t mean there’s nothing that you and I can learn from a Buffett deal like this. In fact, I think this particular Buffett deal is very educational. The Heinz buyout is confirmation, in case you needed it after looking at other recent Buffett deals like his buyout of railroad Burlington Northern, that he believes in what Pimco bond guru Bill Gross has called “the new normal market” and that I’ve called “the paranormal market.”
The Heinz deal makes the most sense if you see the next decade offering relatively modest returns. The new normal and the paranormal paradigms call for, at best, 5% annually from equities. And a continuation of the high volatility of recent markets. In the paranormal market I point to the extreme volatility of 2011 as something we can expect with frequency. For a description of the new normal and the paranormal paradigms see my posts http://jubakpicks.com/2012/03/02/call-it-the-new-paranormal-market-youll-need-some-new-investing-tools-but-the-profits-are-out-there/ and http://jubakpicks.com/2012/05/18/3-buys-for-this-sideways-market-and-more-thoughts-on-the-new-paranormal/
Why do I put the Heinz deal in this camp? Read more
The Shanghai Food and Drug Administration concluded its investigation into chicken sold by Yum! Brands KFC stores in China on January 25, the company said in today’s, February 4, fourth quarter earnings release. The Chinese agency did not fine the company or decide to bring a legal or regulatory case for higher than permitted levels of antibiotics in chicken sold by KFC from supplier Liuhe Group.
That doesn’t mean that investors, though, have cleared the company. The stock fell 1.99% today before the earnings report and then another 5.38% in after-hours trading post for a total loss on the day of 8.2%.
The problem wasn’t fourth quarter earnings—the company actually beat expectations by a penny—or revenue—at $4.15 billion slightly ahead of the $4.12 consensus. Read more