Sizing Up Earnings Season

In October, the market staged its biggest monthly snapback rally since March 2009. A good portion of the change in sentiment surrounding equities mid-month was driven by better-than-expected third-quarter earnings reports. Quarterly results have been hitting the market fast and furious over the past few weeks. Overall, earnings are coming in up nearly 6% year over year, a bit better than the approximately 4.5% rise forecast before third-quarter reporting began. Although beating expectations, growth is not that impressive given the valuation of overall market, which is 15% to 20% above historical norms on an earnings basis. Some leeway has to be given the low level of interest rates and lack of investment alternatives. Growth is impressive, however, given S&P 500 margins are at or near all-time highs and with the current tepid global demand. There are emerging trends that I believe are actionable. One theme is the mania surrounding Ebola, which was just that: media-driven hysteria. I recently wrote on Real Money Pro that investors wanted to buy airline stocks such as American Airlines (AAL) and Delta Airlines (DAL) when they dropped below $30 per share when the U.S. first reported a few cases of the lethal disease. Those stocks are now above $40 a share. I have sold out-of-the-money covered calls on these positions last week. Based on the results from Southwest Airlines (LUV), United Airlines (UAL) and Spirit Airlines (SAVE), however, the industry is posting better-than-expected results. I would look for these airlines to benefit even more from falling oil prices and robust holiday travel in the fourth quarter. In addition, other travel-related stocks saw few effects from the Ebola scare. Online travel site Expedia (EXPE) posted stellar results last week. I would expect good results from Priceline (PCLN) Tuesday as well. This company traditionally provides very cautious guidance during its conference call after results, which sometimes unnecessarily pressures the stock. If this happens during its earnings call tomorrow amid good results, I will be stepping in to buy the dip. I have also noticed that the refinery sector is doing much better than expected. Chevron (CVX) and Exxon Mobil (XOM) both beat earnings expectations, driven by strong results from their downstream operations. In addition, refiners Tesoro (TSO), Phillips 66 (PSX), Marathon Petroleum (MPC) and PBF Energy (PBF) all easily beat estimates when they delivered results last week. Based on these reports, it is hard to see how Valero (VLO) and Delek US Holdings (DK) do not beat estimates when they report this week. I particularly like Valero, which is the largest refinery stock in the market. The company has easily beat the consensus three of the last four quarters. In addition, low corn prices should bolster its ethanol business, which is more than 10% of revenues. Valero is the best-positioned refiner to benefit from rising exports given its facilities on the Gulf coast and now has dropdown opportunities via Valero Energy Partners LP (VLP), which came public late last year. Even with the recent rally in the refinery sector over the past couple of weeks, the shares are still down more than 15% from its recent highs this year. The stock goes for just 9x this year's earnings, and it yields 2.2%. We still have a ways to go to get through third-quarter earnings season, but the results so far are encouraging given the challenging global environment.

Sizing Up Earnings Season

Here are the emerging trends that I believe are actionable.

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