The Week Ahead:! Good News Should Be Good News
Stock Market: More QE Concerns – More Volatility!
The Game Plan: Earnings Begin – AA, YUM, JPM, WFC!
Wall Street: Bonds In Focus!
by Ian Harvey
July 08, 2013
The Fed probably will be the major driver for equities in the week ahead as earnings season kicks off -- traders will be keeping one eye on the bond market, wary that rising rates could sting stocks. A big selloff in the metals and Treasury bond markets is very likely.
Fundamentals will return to the forefront as companies begin to release second-quarter results in the week ahead. Expectations call for S&P 500 earnings growth to rise 1.6 percent in the second quarter from a year ago, while quarterly revenue is forecast to increase 2.9 percent from a year ago.
Dow component Alcoa Inc (AA) will post results after the market closes on Monday. JPMorgan Chase & Co (JPM) and Wells Fargo (WFC) are also set to report results later in the week ahead.
There are also a number of economic reports in the week ahead, including inflation data and consumer sentiment. Minutes of the last Fed meeting are released Wednesday, and Fed Chairman Ben Bernanke speaks after the market closes that day to the National Bureau of Economic Research conference.
Also, geopolitical tensions will be in focus for traders, keeping an eye on the situation in the Middle East. U.S. crude oil prices rallied this past week above the $100 a barrel mark amid supply concerns sparked by tumult in Egypt and speculation strength in the American economy will drive demand higher.
• ‘The Past Week’
• ‘The Upcoming Week’
• ‘The Economy’
• ‘The Fed and Volatility!’
• ‘Earnings and Company News’
• ‘A List of Key Events’
• ‘The Spotlight on Certain Companies’
• ‘The Fed!’
• ‘Earnings Expectations’
• ‘Overseas Influence on the Stock Market!’
• ‘The Fed and Tapering’
• ‘The Bond Market’
The Fed in the Week Ahead
Investors were encouraged to see signs of improvement in the job market, but the report also makes it more likely that the Fed will begin to taper its stimulus policies later this year.
The Labor Department said the economy added 195,000 jobs during the month. Economists had expected a gain of 165,000 jobs. In addition, the report estimated the private sector added 202,000 jobs, also more than expected.
Further, overall nonfarm payroll gains in May and April were revised higher by a total of 70,000. The unemployment rate held at 7.6%, as many people rejoined the workforce and started to look for jobs.
Wall Street's interest in the jobs report has intensified since late May because the Fed has been talking about "tapering" its bond purchases.
It's been buying $85 billion a month in Treasury and mortgage securities to keep rates low to support the recovery. But Chairman Ben Bernanke has been saying the Fed may not need to continue purchasing securities at that rate for much longer.
While Bernanke and other officials have said the Fed won't change the target on its federal funds rate -- now 0% to 0.25% -- that talk alone has pushed longer-term interest rates higher, like the 10-year Treasury. Many economists said Friday the Fed is likely to announce the first taper at its September meeting.
While the unemployment rate was unchanged last month, economists say the gains in hiring -- including past months that were revised higher -- mean the rate should head lower in the months ahead.
There will be two more reports on the unemployment rate and hiring before the Fed's next scheduled meeting in September.
The Fed and Volatility!
Any tapering by the Fed would reflect an improved outlook for the economy and should bode well for stocks. But traders say volatility will remain high in the short run as the Fed's next move remains uncertain.
On Wednesday in the week ahead, the Federal Reserve will release the minutes from its June 18-19 meeting. Those minutes are likely to attract heightened attention from Wall Street since they are coming out on the same day that Bernanke speaks to the National Bureau of Economic Research.
The consensus on when the Fed will start cutting back its stimulus sits firmly in September of this year, with 11 of 16 primary dealers believing that, according to a Reuters poll, compared with seven of 17 in the June 19 Reuters poll.
On May 22, Bernanke said the quantitative easing program would be slowed if economic growth met the Fed's targets. Investors interpreted that as an indication of an early exit, sparking a steep slide in stocks and a surge in U.S. Treasury yields that prompted Goldman Sachs to close its recommendation that investors buy rate-sensitive names.
Earnings Expectations in the Week Ahead!
Earnings will start to come back in the forefront in the week ahead, and many analysts believe that the earnings season will look a lot like Q1 earnings season, where expectations were marked down a lot -- the expectations are a 1 percent earnings growth and 1 percent revenue growth.
Expects earnings growth to come in several percent better than expected, as it has in recent quarters, but revenues are likely to stay flat.
So far, earnings pre-announcements have been extremely negative. Through last Friday, the ratio of negative to positive comments is 6.5 to 1, more than 2 1/2 times the normal pace and the most negative reading since 2001.
Guidance is particularly important for the earnings season since there is going to be a lot less Fed accommodation.
The quantitative easing program has been credited with helping push stocks higher, and the Fed has said it would start winding down the $85 billion-a-month bond-purchasing program by year-end. Friday's stronger-than-expected June jobs report has many traders now expecting the Fed to begin reducing its bond purchases as early as September. A survey of economists, fund managers and strategists showed that a clear majority now expect the central bank to begin tapering in September or October with an average reduction of $22 billion.
”….. U.S. stocks closed with sizable gains Friday following a choppy, post-holiday session, as a stronger-than-expected jobs report helped the main indexes achieve a second up week in a row, even as the 10-year yield rose to 2.73 percent, its highest level since August 2011. Stocks sold off early but ended the day up 1 percent, even as rates continued to rise......”
- The Past Week in the Stock Market – July 08, 2013
The debate over when the U.S. Federal Reserve will start to withdraw liquidity will continue to rage, especially with the European Central Bank and the Bank of England turning more dovish. But the focus will shift to China and the impact it is having on global growth.
Meanwhile, the minutes from the Fed’s last policy meeting will come out Wednesday. Plus, Fed Chairman Ben Bernanke will deliver a speech Wednesday.
On Friday, stocks jumped out of the gate after the U.S. government said the economy added a much-better-than-anticipated 195,000 jobs in June. The main indexes then briefly slid into negative territory in mid-morning trade, but recovered to close at fresh session highs.
A number of strategists indicated on Friday that they see the Fed starting to curtail its bond-buying program that’s boosted stocks around September. Goldman Sachs economists moved forward their forecast for the beginning of tapering to September from December.
The Economy in the Week Ahead
The economic calendar is rather light in the week ahead in a stark departure from the week that just ended. However, the FOMC minutes due out on Wednesday and a speech from Federal Reserve Chairman Ben Bernanke highlight the week in economics.
Minutes from the central bank’s June meeting come out on Wednesday. Traders will be searching for any details on what thresholds the Fed will use in determining when to hike rates and taper QE. Chairman Ben Bernanke also speaks that afternoon on the history of monetary policy. Three regional Fed chiefs are also set to make public appearances on Friday, according to Bloomberg News.
Major economic data releases due out over the course of the week focus mostly on June inflation. The price level and expectations for future changes in prices are a statistic the Fed watches closely in setting its monetary policy. For the most part, economists are in agreement inflation is in check, but with the Fed’s aggressive easing, upside or downside surprises could drive markets higher or lower.
A reading on import and export prices from the Labor Department is slated for Thursday. A gauge of wholesale-level prices, also from Labor, comes out the following day. The more closely-watched report on consumer prices is on deck for the following week.
Rounding out the economic data is a preliminary reading on consumer sentiment for the month of July from Reuters and the University of Michigan.
Overseas Influence on the Stock Market for the Week Ahead
In the week ahead, ECB President Mario Draghi testifies at the European Parliament in Brussels on Monday, and there is also a Eurogroup meeting that day, ahead of Tuesday's ECOFIN meeting. The euro zone finance ministers are expected to decide whether to approve the latest 8 billion euro tranche of bailout funding for Greece.
With yields and the dollar rising, commodities should continue to falter. Crude, however, has been surging on political uncertainty in Egypt, where the military facilitated the removal of President Mohammed Morsi and protests continue. WTI crude, above $103, was up nearly 7 percent in the past week in its biggest weekly gain since October 2011.
The Fed and Tapering in the Week Ahead
Economic data will continue to be important in the week ahead, as traders monitor progress of other measures of job growth. One such report will be the Treasury's job openings and layoffs report Tuesday.
The stock market's base case seems to be that the economy will continue to build momentum and the Fed will taper its bond buying.
But there is a presentation of a case where others see it differently. Even though reports at the end of the second quarter -- the big three reports were ISM, above 50, auto sales were close to 16 million and the unemployment report -- were pretty strong – but not yet solid for a breakaway level. With equity values already close to record highs, in a still soft economy, stocks can't continue to rise with rising rates, and a correction would not be a surprise.
The debate is going to continue, as many feel that the economy is clearly not strong enough, and the equity market is going to continue to be concerned about the Fed leaving too early, which is a valid concern.
Also a concern is that rates will rise so much that economic activity is hampered, particularly in the housing sector. A 10-year yield of 2.75 percent sends mortgage rates closer to 5 percent for a 30-year conventional mortgage.
The Bond Market in the Week Ahead
The stock market also will be watching the bond market in the week ahead, after yields moved sharply higher after the employment report. Nonfarm payrolls were 195,000, and the unemployment rate was 7.6 percent. Jobs came in 30,000 better than expected, and an additional 70,000 in revisions for April and May took the six month average to 202,000.
Markets will continue to adjust to this dynamic in the week ahead and the reaction to three bond auctions should be telling. The Treasury is auctioning $32 billion in three-year notes Tuesday, $21 billion reopened 10-year notes Wednesday and $13 billion reopened 30-year bonds Thursday.
Rising U.S. rates have pushed the dollar to a three-year high against a basket of currencies Friday, and have sent emerging markets reeling. Brazil's Bovespa, for instance, was down nearly 6 percent in the past week.
The upcoming auctions in the week ahead will be offset by the Fed's Treasury purchases.
Earnings and Company News in the Week Ahead
The 2013 Q2 earnings cycle takes the spotlight in the week ahead, even though the earnings calendar is on the light side with only 7 S&P 500 companies reporting, including Alcoa (AA), Yum! Brands (YUM), J.P. Morgan (JPM) and Wells Fargo (WFC).
Analysts said companies are likely to continue shedding expenses and leaning their operations in order to squeeze every bit of profit out of slowly-growing sales. Barclays reckons S&P 500 earnings will grow at 3.5% in the second quarter from the same three months in 2012, while revenues increase a stodgier 1.9%.
Barry Knapp, the British investment bank’s head of equities strategy, also warned in a note to clients this week “in each of the last two years, July has marked the start of a significant period of tempering in full year estimates.”
Alcoa, the embattled aluminum maker, unveils its quarterly figures after Monday’s closing bell in the week ahead. Discount retailer Family Dollar Stores (FDO) is set to reveal its results before the market opens on Wednesday, and Taco Bell parent Yum Brands (YUM) posts after the close of trading that day.
Banking behemoths J.P. Morgan Chase (JPM) and Wells Fargo (WFC) step up to bat ahead of the bell Friday. Financial sector earnings are under intense scrutiny as banks deal with a slew of new regulations and a market that changed dramatically in the wake of the 2008 financial crisis.
Expectations for Q2 earnings remain quite low. Total earnings for companies in the S&P 500 are expected to be up only +0.4% from the same period last year on -0.8% lower revenues and modestly higher margins. This is sharply down from +3.9% growth expected in early April.
Nine of 16 sectors observed are expected to show negative earnings growth in Q2. But the growth picture in Q2 is even more underwhelming when Finance is excluded from the data. Outside of Finance, total earnings for the S&P 500 would be down -3.2%. Total earnings were up +2.6% in Q1, but growth was expected to be in negative territory at this stage before that reporting season.
Finance at the Forefront Again!
Finance wasn’t a big driver of aggregate earnings growth in 2013 Q1, but the sector takes back the lead role in Q2, with total earnings expected to be up +18.6% and estimates for the group steadily rising. Earnings for the sector were up +7.6% in Q1, which came after many quarters of double-digit growth.
All the industries within the Finance sector -- major and regional banks, brokers and insurers -- are expected to have positive growth. But the growth picture is particularly notable for the brokerage and investment management industry players like Goldman Sachs (GS) and Morgan Stanley (MS), with total earnings for the group expected to be up +38.7% in Q2 after the +2.6% gain in Q1.
Unlike Finance, the earnings picture for the Technology sector remains fairly weak. Total earnings for the sector are expected to be down -8.3% from the same period last year, which follows the -4.2% earnings decline in Q1. Earnings estimates for the sector steadily came as the quarter progressed, with the current -8.3% decline down from the expected decline of -3.1% in mid-April. Excluding Technology, total Q2 earnings for the S&P 500 would be up +2.4% from the same period last year.
The weakest group within the Technology sector is the PC makers, with total earnings for the Computers and Office Equipment industry expected to be down -16.1% in Q2 after the -14.1% decline in Q1. Semiconductors and electronics are other Tech industries with negative earnings growth in the quarter, while the software group is expected to show a modest positive growth.
Expectations are High for Second Half & Next Year
Expectations for total earnings in 2013 have come down as estimates for Q2 were revised lower, though estimates for the second half of the year and full-year 2014 have held up fairly well. The +6.4% growth in total earnings this year, down from +6.8% in early April, reflects a material ramp up in the second half of the year that is then expected to carry into 2014.
Combining the actual results for Q1 with estimates for Q2 gives us +2.7% year-over-year growth in total earnings in the first half of 2013. But total earnings are expected to be up +9.2% in the second half of the year and a further +11.5% in full-year 2014.
Total earnings for companies in the S&P 500 in Q2 are expected to remain below Q1’s record level. By calculation, aggregate bottom-up earnings in Q2 will total $250.3 billion, compared to $249.3 billion in 2012 Q2 and 2013 Q1’s record of $252.6 billion. The Finance sector will generate $48.7 billion or 18.7% of the S&P 500’s total Q2 earnings, while the Tech sector is expected to generate $43.5 billion or 16.6% of the index’s total earnings.
Finance is reclaiming its dominant earnings position in the index which was taken over by the Tech sector following the 2008 crash. Tech remained the biggest earnings producer for the S&P 500 from 2008 through 2012, but the leadership role moves back to Finance this year. Finance is on track to produce $198.1 billion in 2013 (19.2% of the total), up from $173.7 billion in 2012 (17.9% of the total), while Tech is expected to produce $186.1 billion this year (18% of the total), up from $181.9 billion in 2012 (18.8% of the total).
The Spotlight on Certain Companies in the Week Ahead
Alcoa in the Week Ahead
Alcoa is expected to report second quarter results after the close on Monday. Analysts expect the company to report EPS of $0.08 vs. $0.06 in the second quarter of 2012. Revenue is expected to have fallen slightly to $5.92 billion from $5.96 billion in Q2 2012.
The analyst team at JP Morgan weighed in ahead of earnings. The bank last week downgraded the stock to neutral from overweight and lowered its price target to $9 from $12.
“Alcoa has clearly taken steps to lower its costs in its upstream segments and to grow its downstream businesses. However, we believe these efforts will be largely overshadowed by a persistently weak aluminum price environment, which should weigh on AA's earnings and stock price. Additionally, outside of aluminum prices materially increasing or investor sentiment on the sector significantly improving, we see few catalysts for Alcoa's stock in the near term.”
Deutsche Bank is also cautious ahead of the earnings report, reiterating its neutral rating and $9 price target for Alcoa.
“We expect Alcoa to report adjusted diluted EPS of 5c in 2Q13, below the FactSet consensus of 7c (down 4c over past 4 weeks). Our EPS estimate is 6c lower than 1Q13, largely due to softer aluminum price realizations on weaker LME benchmark and lower premia.”
“Market likely to focus on Alcoa's forecasts for global aluminum trends, progress towards the Ma'aden smelter and rolling mill launch targeted for 4Q13, as well as direction of Alcoa's net debt position (DBe at $7.7bn, +$280m QoQ).”
Meanwhile, Bank of America Merrill Lynch is also cautious on the stock into earnings, as the bank also reiterated a neutral rating and $9 price target ahead of earnings.
“We forecast EPS of $0.06, below consensus of $0.08 and last qtr's $0.11 largely due to a 8% q/q drop in 15 day- lagged LME pricing offsetting seasonal improvement in its mid- and downstream segments.”
“To lessen cash burn in a weal Al price scenario AA can: 1) cut its $550M of growth capex, 2) pay pension costs with stock vs. cash, 3) sell non-core assets, and 4) enhance productivity gains and cost cutting, i.e. close high-cost facilities. A Moody's downgrade to junk in late May should have minimal impact as less than $1B debt matures over the next four years and a revolver matures in 2017E.”
Lastly, Goldman Sachs also reiterated a neutral rating and $8 6-month price target on Alcoa into earnings.
“We have marked to market our second quarter estimates for Alcoa to reflect the actual realized LME aluminum price of $0.84/lb compared to our estimate of $0.91, which reduces our 2Q13 estimate for AA to $0.05 from $0.13. We also lower our full year 2013 estimate to $0.35 from $0.42.”
“For the 2Q conference call, investors' focus will likely be on the balance sheet and cash burn - including a possible equity issuance to shore up the balance sheet - in addition to portfolio restructuring, market outlook, and growth projects like aluminum-lithium and auto aluminum rolling facility.”
J.P. Morgan Chase in the Week Ahead
”Fortress Dimon” is expected to report second quarter results on Friday. The company is expected to report second quarter EPS of $1.43 vs. $1.15 a year ago on revenue of $24.942 billion vs. $22.18 billion a year ago.
Sterne Agee in June raised its price target on JP Morgan to $64 from $54 and raised its estimates for earnings. The bank maintained its buy rating on the stock.
“Although top-line growth will remain challenging heading into '14, better-than- expected capital markets, lower environmental related costs and ongoing credit leverage will likely offset lackluster revenues. And, heavy reserve release in consumer/community banking and resilient FICC trading results should continue to help offset slowing mortgage banking.”
“For 2013, our operating estimate increases to $5.80 from $5.50, while our 2014 estimate increases to $6.15 from $5.85. After a relatively soft and erratic April, capital markets activity, consumer confidence, and housing have thus far registered ahead of expectations this quarter.”
“In addition, credit quality improvement continues to outpace expectations following the severity of the financial downturn, suggesting that the magnitude and duration of credit leverage in the industry is likely far greater than current expectations. Conversely, loan growth remains weak, mortgage banking is slowing and pressure on margins is mounting.”
“Notwithstanding the challenges, with JPM trading at a discounted ~8.5-9x forward earnings, we believe the shares are poised for multiple expansion given the tailwinds tied to housing, employment and our sense of a diminishing regulatory overhang heading into 2014.
Accordingly, we are increasing our 12-month price target to $64 from $54, which implies about 10.4x our revised 2014 estimate of $6.15 and 1.4x our estimated 2014 tangible book value.”
Yum! Brands in the Week Ahead
Restaurant operator Yum! Brands is expected to report second quarter earnings on Wednesday. The company is expected to report second quarter EPS of $0.54 vs. $0.67 a year ago on revenue of $2.916 billion vs. $3.168 billion.
Morgan Stanley analysts are positive heading into the report, maintaining an Overweight rating and a $75 price target.
“We are constructive into 2Q results given our view that June China [same store sales] will show continued improvement as the avian flu subsides. China margins remain the biggest concern and negative macro is becoming an issue, but we think YUM's LT opportunity remains intact.”
“We also view strength at China Pizza Hut (+12% in May) as evidence that underlying consumer demand trends are solid. We estimate 3Q13 and 4Q13 China SSS of -6% and +5%, vs. the consensus of -8% and +3%.” Morgan Stanley expects EPS of $0.52.”
Meanwhile, Goldman Sachs is rather more cautious heading into earnings here. Goldman has a neutral rating and a 12-month of price target of $70 on the stock.
“YUM reported May China SSS of -19%, inline with consensus. In terms of composition, KFC came in at -25% (from the ongoing impact of Avian Flu), while Pizza Hut was solid at +12% despite some recent macro choppiness. While solidly negative, these figures represent a sequential improvement from April's -29% SSS run rate (KFC -36% vs. Pizza Hut +5%), and YUM reiterated its expectation of a return to positive China SSS by 4Q13.”
“We raise our 2013-2015 EPS estimates to $3.02/$3.63/$4.13 from $3.00/$3.57/$4.07. While China SSS were inline with expectations, our updated estimates now reflect food cost deflation in China, a weaker USD and lower interest rates. We raise our P/E and DCF-based 12 month price target by $1 to $70 to reflect the higher estimates.”
Meanwhile, Bank of America Merrill Lynch is much more bearish than its two competitors here. BAML has an Underperform rating and a $60 price objective on Yum! stock.
“While sales came in roughly where we expected, given the stock price moves into the release we believe sales probably had to come in closer to down 10%-15% to meet current investor expectations. Yum shares advanced sharply [in the beginning of June] due to reports of an independent survey that indicated KFC China's May comps may have been halved (or even more than halved) from the down 36% in April.”
“We continue to rate YUM shares Underperform with a $60 price objective. We remain cautious on the earnings implications for 2013 and 2014 from the triple header of sales issues that began with negative 4Q12 comps related to brand specific marketing and promotions decisions and continued into 1Q13 and 2Q13 with antibiotic chicken issues and H7N9 avian flu concerns, respectively. While we believe the long-term potential for YUM is still significant, the market seems complacent about YUM's ability to get back to its normal earnings trajectory in 2014 as if current sales trends are irrelevant.”
A List of Key Events for the Week Ahead
All earnings dates listed below are tentative and subject to change. Please check with each company's respective website for official reporting dates.
• Earnings: Alcoa (NYSE: AA) and WD-40 Company (NASDAQ: WDFC).
• 3:00 p.m.: Consumer credit
• Earnings: ADTRAN (NASDAQ: ADTN), Healthcare Services Group (NASDAQ: HCSG), and Wolverine World Wide (NYSE: WWW).
• 7:30 a.m.: NFIB small business survey
• 10:00 a.m.: JOLTS survey
• 1:00 p.m.: Three-year auction
• Earnings: Fastenal (NASDAQ: FAST), Family Dollar (NYSE: FDO), PriceSmart (NASDAQ: PSMT), Ruby Tuesday (NYSE: RT), and Yum! Brands (NYSE: YUM).
• 10:00 a.m.: Wholesale trade
• 1:00 p.m.: 10-year-note auction
• 2:00 p.m.: FOMC minutes
• 4:10 p.m.: Fed Chairman Ben Bernanke speaks at NBER conference on a century of central banking, Q&A
• Earnings: Commerce Bancshares (NASDAQ: CBSH), Progressive Corp. (NYSE: PGR), and Peregrine Pharmaceuticals (NASDAQ: PPHM).
• 8:30 a.m.: Initial claims
• 8:30 a.m.: Import prices
• 11:00 a.m.: Fed Gov. Daniel Tarullo testifies before Senate Banking Committee
• 1:00 p.m.: 30-year bond auction
• 2:00 p.m.: Federal budget
• Earnings: Infosys (NYSE: INFY), J.P. Morgan Chase (NYSE: JPM), Webster Financial (NYSE: WBS), and Wells Fargo (NYSE: WFC).
• 8:30 a.m.: PPI
• 9:55 a.m.: Consumer sentiment
International Economic Reports in the Week Ahead
• Monday - Swiss unemployment rate, German industrial production and the Chinese inflation report.
• Tuesday - British industrial production
• Thursday - The Australian employment report
• Friday - Eurozone industrial production