This commentary was excerpted from the weekly roundup sent to subscribers of Action Alerts PLUS, a charitable trust co-managed by Jim Cramer and Jack Mohr. Click here to learn about this actively traded stock portfolio.
Despite a valiant effort by the financials on Friday, markets coughed up early gains on upbeat earnings and positive macro data to end the week's last trading session on a flat note, failing to keep the major indices from closing out the week in the red.
From the start, Alcoa's (AA) relatively weak earnings on Tuesday failed to inspire confidence across the industrial sector, leading to a selloff that was only exacerbated by strengthening in the dollar. Although markets managed to finish flat on Wednesday following a reading of the Fed's meeting minutes, which lacked a definitive opinion on an upcoming rate hike, stocks slid again on Thursday following weak trade data out of China that indicated potentially weak global demand and sluggish economic activity within the world's second-largest economy. That being said, a reversal in oil prices in the afternoon session helped close the day on a positive note, and the momentum continued into Friday, when the financials posted solid quarterly results.
Looking ahead, a crowded earnings season should help distract investors from a heightened focus on rates, although intermittent comments from individual Federal Reserve officials will likely continue to be market-moving.
For the week, Treasury yields were roughly flat as investors searched for a clear timing on a future rate hike, but were denied any specifics in the Fed's meeting minutes. The dollar, however, strengthened against the euro for the majority of the week as Brexit concerns moved to the front of the headlines. Gold trended lower for the third straight week and crude oil prices ultimately moved higher, flirting with the $50 threshold for the majority of the week.
Third-quarter equivalent earnings have kicked off and have been relatively mixed, but somewhat positive compared with expectations, as 76.7% of companies have surprised to the upside vs. estimates. Alcoa, Wells Fargo (WFC) , and Citigroup (C) each reported earnings for the portfolio this week.
Alcoa's 3Q results missed consensus on the top and bottom lines. Revenue of $5.2 billion (down 6% on the previous year period) missed consensus of $5.3 billion (down 5%) and earnings of $0.32 per share missed consensus of $0.35. Within the quarter, continued pricing headwinds in key commodities (i.e., alumina) and negative FX impacts more than offset favorable volumes, although strong productivity gains drove higher profitability year over year. During the quarter, automotive and heavy duty truck/trailer remained strong, especially in China and Europe, and the company expects the momentum to continue moving forward. Aerospace continues to be the laggard, with management now expecting growth at the lower end of its previously revised 0% to 3% guidance range (the initial 2016 guide was 8% to 9%). CEO Klaus Kleinfeld noted that pre-stocking of airframes in prior quarters is sucking up much of current demand, contributing to the downside as we head into 2017. On the positive side, however, ramp-ups of new engine launches are seeing "massive demand" from customers. Once the company perfects the supply-chain processes for these new products (reaching a 'steady state' of production), management expects margins to improve toward an optimal level.
Wells Fargo delivered a top- and bottom-line beat with its third-quarter results, as revenue of $22.33 billion (up 2% on the previous year period) came in slightly ahead of consensus of $22.22 billion and EPS of $1.03 beat consensus by $0.02. Results were moderately positive, although less so than many of the other banks that have reported. Net interest income increased $219 million, to $12 billion, mostly as a result of growth in investment securities, loans, mortgages held-for-sale and trading assets. Net interest margin, however, declined 4 basis points sequentially -- to 2.82% -- as the bank saw growth in longer-term debt and deposits. Net interest income made up 54% of revenues and non-interest income comprised 46%, demonstrating the bank's consistent diversification. On the other hand, third-quarter expense increased as a result of increased operating losses, reflecting higher litigation accruals, as well as higher salaries and other expenses. Thus, the efficiency ratio was 59.4%, higher than the 58.1% in the second quarter, and above management's prior target of 55% to 59%. While we view the print as solid, we recognize that investors remain focused on the sales practice investigations, especially given the relatively stronger performance of other financials.
Meanwhile, Citi reported revenues of $17.8 billion (down 4.8% year over year), which beat consensus of $17.3 billion. EPS came in at $1.24, or $0.08 ahead of Wall Street expectations. Importantly, tangible book value in the quarter increased 8% year over year to $64.71, representing a 33.5% premium to Thursday's closing price. Notably, the bank is seeing momentum in some of the key areas in which it has been investing over the recent years: in the quarter, both the Institutional Clients Group (ISG) and Global Consumer Bank (GCB) had year-over-year revenue increases in nearly every business line and geography. Also during the third quarter, Citigroup returned a total of approximately $3.0 billion of capital to common shareholders in the form of dividends and repurchases of approximately 56 million common shares. Recall that the bank recently raised its dividend and share buyback program following its positive CCAR review over the summer. Management remains focused on shareholder returns, and given the discount to TBV, any buybacks are truly accretive.
Moving onto economic information, the week started off slow with Columbus Day on Monday, but investor focus quickly shifted to Wednesday's release of the Fed's minutes from its September policy meeting. Leading up to the release of the minutes, bond yields and the dollar rose in the first half of the day as investors placed their bets on a December rate hike, discounting the potential for a move in November. According to the CME's Fed Watch Tool, the probability of a rate hike at the November meeting is just 9.3% while the probability of a hike at the December meeting sits at 69.9%.
Once the meeting minutes were released, stocks were little changed on Wednesday afternoon trading as the Fed, in its typical fashion, seemed noncommittal on its rate hike outlook, noting the need for additional data to confirm the economy's direction. As has become custom in the central bank's recent meetings, there were disagreements from those who viewed the decision as a close call and those who required more data supporting a hike. The topic of the labor market appeared to be the culprit of the growing divide, with one camp calling out remaining slack while others were concerned that continued pumping of cheap money into the economy could cause the labor market to tighten too quickly. That being said, the general feeling of the FOMC seemed to reinforce the belief that there would be a move in December -- 14 of 17 Fed officials indicated they expected to raise rates before the end of the year.
Regardless, we expect the committee to remain data-dependent, judging improvements in the economy up to the very moment of the start of the Dec. 13-14 meeting. While reports since the Sept. 20-21 meeting have been largely positive -- with manufacturing showing improvements and the labor market displaying continued strength (in persistently low claims, rising rages, and higher participation) -- we also recognize that movements abroad, such as the fall of the British pound and weak Chinese data, complicate the Fed's discussions as resulting increases in the dollar could curb inflation and limit exports. Individual Fed officials will continue to voice their opinions in the coming months, likely moving markets, but we must be careful not to be overly captivated by these comments, which have led markets astray over the past year. Bottom line: we will keep an eye on the data.
On Thursday, the Department of Labor reported that initial jobless claims for the week ending Oct. 8 were 246,000, which was flat with last week's revised figure and 8,000 claims lower than expectations. Further, claims have remained below 300,000 -- the threshold typically used to categorize a healthy jobs market -- for an astounding 84 straight weeks, which remains the longest streak since the early 1970s. The four-week moving average for claims (used as a gauge to offset volatility in the weekly numbers) fell 3,500 claims to 249,250, the lowest level since November 1973. This strong report comes a week after the September jobs numbers were released (employers added 156,000 jobs, lower than expectations, but wages rose and participation was higher than previous months) and indicates that the labor market continues to be a driver for economic activity. As the Fed continues to balance data across various industries and markets, continued strength in the labor market will be a requirement should the committee look to move on rates in December. Claims have been one of the most consistently bullish figures over the recent years, and for now, the momentum appears to be strong.
On Friday, the Commerce Department reported that retail sales increased 0.6% in September, in line with expectations, yet a positive reversal from August's 0.2% revised decline. The increase in September was the largest for retail sales in the past three months. The positive performance was driven by purchases of motor vehicles and continued increases in gasoline (as oil prices have risen higher since the middle of the summer -- the average price for a gallon of regular gasoline in September was $2.16, up $0.04 from August). Excluding both automotive and gasoline purchases, September sales were up 0.3% from August. This core metric had been estimated to hit a 0.4% increase.
Importantly, we point out a continued consumer shift to e-commerce and away from bricks-and-mortar as sales in a category that encompasses online retailers were up 11% year to date vs. a 4.8% advance for traditional retail stores. This same shift has cause investor sentiment to sour on many retail stocks throughout the past year. We continue to view TJ Maxx (TJX) positively in this light given its unique shopping experience and customer value proposition.
Recall that retail sales are a closely followed metric as consumer spending accounts for more than two-thirds of overall U.S. economic activity. With September's results now in the books, total sales in 3Q were 0.7% higher than 2Q and rose 2.4% compared with the 3Q 2015. Retail sales were up 2.9% YTD compared with the same period in 2015.
On the commodity front, crude oil kicked off the week on a hot note Monday as investors jumped into the trade to reverse last Friday's decline after Russian President Vladimir Putin voiced his support for curbs on petroleum production. The announcement was market-altering as Russia had been viewed as one of the key unknowns outside of OPEC's agreed-upon production deal. Russia currently pumps more crude oil than any other country, so the prospect of joining a common effort to limit oil production is a positive sign for urging others to do the same. Bluntly, Putin stated, "We believe freezing or even reducing oil production is the only way to save the stability of the energy sector." The pledge by the Russian president is indicative of how dire the situation has become, with the glut only becoming larger with each growing month.
That being said, we still remain skeptical of the entire scenario as any recent comments, both from Russia and OPEC, have proven to be an effort to manipulate crude prices higher rather than a true promise. OPEC is scheduled to meet again in Vienna on Nov. 30 and we expect commentary from individual nations to continue to drive the trade in the short term. According to the <i>Wall Street Journal</i>, recent increases in oil prices over the past two weeks since the production agreement was announced in Algeria have delivered OPEC and Russia an additional $2.8 billion in revenue -- easy to see why these groups continue to prop prices higher, regardless of the truth behind the commentary.
Following Monday's sharp increases, crude prices trended lower for the rest of the week as several market-wide reports pointed toward continued fundamental issues. First, a monthly report from the International Energy Agency (IEA) on Tuesday noted that global supplies rose in September, hitting 97.2 million barrels per day, a 600,000 barrel per day advance from the prior month. Coincidentally, the majority of the increases came from Russia. As we noted above, intentions and actual actions are clearly far from being aligned with one another.
On OPEC specifically, the IEA indicated that the cartel boosted its output by 160,000 barrels per day to a record 33.64 million barrels. Iran, Libya, and Nigeria were the main producers increasing output, which is unsurprising given the recent removal of trade sanctions in Iran and pipelines that have come back online in Libya and Nigeria. Evidently, there is a long way to go to cut down the global oversupply, highlighting the importance of OPEC's proposed production agreement. Should the countries not follow through on their promises, crude prices will undoubtedly see recent increases retrace back toward early summer levels, testing recent lows. An under-the-radar issue is that most producing nations are looking to raise output heading up to the upcoming OPEC meeting in order to raise their base throughout the bargaining process. In this case, following through on the agreement becomes even more vital.
Moving forward in the week, oil prices took another hit on Wednesday after OPEC's monthly update seemed to include some production numbers that were contrary to recent reports and analyst expectations, raising questions that some producers are attempting to get away without production cuts -- essentially, by reporting higher-than-actual output numbers, a production cut off of the higher base would in fact not be a cut at all.
Prices found some support on Thursday, however, when weekly inventory reports noted larger-than-expected drawdowns in gasoline and other product stockpiles, reversing major losses across the broader indices. Although crude oil inventories increased, the product declines were key as they indicated perhaps better-than-expected demand, easing the glut in gasoline that has troubled investors in recent months.
Regardless, while the weekly reports provide a peak into current trends, the oil market is placing all its eggs in OPEC's basket for now. We await further news of the production agreement and remain wary of the constant volatility in crude oil prices and the impact on the broader markets.
Within the portfolio this week, we took advantage of several down days to add to our Newell Brands (NWL) position. We had been searching for opportunities to add to this new AAP name since bringing it into the portfolio, so we welcomed the dip in the markets. We will continue to capitalize on unwarranted selloffs in Newell as we view the company as one of the few that can differentiate itself from the broader market as it streamlines its brand portfolio with higher-margin, higher-growth products and as it benefits from synergies via the Jarden acquisition.
Moving onto the broader market, as we mentioned, third-quarter earnings have been mixed, but largely better than expected, proving to be positive compared to estimates. Total third-quarter earnings growth is up 1.2%; of the 29 non-financials that reported, earnings growth is 1.7%, vs. expectations for an overall 1.7% decrease throughout the season. Revenues are up 2.7% vs. expectations throughout the season for a 2.43% increase. Of those that have reported, 76.7% of companies have beaten EPS expectations, 20.0% have missed the mark and 3.3% have been in line with consensus. On a year-over-year comparison basis, 76.7% have beaten the prior year's EPS results, and 23.3% have come up short. Consumer Staples and Information Technology have had the strongest performance vs. estimates thus far, while Consumer Discretionary and Materials have posted the worst results in the S&P 500.
