Alcoa Miss Spells Trouble for Q4 Earnings

Includes: AA, DTO, IYK, SCC, SDS, SPY, USO
by: TraderRob

Earnings season officially began as the first member of the S&P 500 and Dow Jones Industrial Average to grab Q4 2009 earnings headlines, Alcoa (NYSE:AA), reported a net profit of $0.01 EPS on Monday, January 11. The shortfall to the $0.06 EPS market consensus was explained by CEO Klaus Kleinfield by the unexpected weakness in the dollar, combined with higher energy prices.

While Alcoa is only one company, the firm is symbolic of the U.S. manufacturing sector as a whole and it's profits are directly affected by the prices of input commodities, primarily petroleum products and aluminum ore. Below is a 1-year chart of the S&P 500, annotated according to AA earnings results vs. estimates.

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SPX 1-12-09

As shown above, the S&P 500 has rallied from the announcement of AA earnings following each of the past three quarterly announcements. The once discarded industrial giant has found new importance over the past year in financial markets as it foreshadows the industrial earning power of the U.S. The recent two quarterly results beat estimates, while the Q1 2009 results were very near the street's consensus at the end of a period wrought with massive earnings let downs. All in all we see the first three AA quarterly results of 2009 as better than expected.

Naturally, Alcoa can't dictate the earnings of an entire economy, but the two factors causing the firm to miss earnings will be applied to bottom lines as earnings season picks up in the following weeks. These factors were higher energy and aluminum ore costs combined a weaker U.S. dollar. The macro economic message heard on Wall Street highlights real revenue destruction from a weaker domestic currency and the negative cost effects of higher oil.

The following two charts show the trend of these two factors of production below in the form of the USD index and the WTI Continuous contract.

US Dollar Index, 1 year chart, January 12, 2010WTI Continuous Crude Oil Contract, January 12, 2010 Referring to the charts, the cost of petroleum based inputs to production and the devaluing of the U.S. dollar during the months of October to December 2009 are both evident. Immediately, traders and investors have begun applying heavier weights to these parameters when running their earnings models. Will this trend be the thorn in the side of earnings to bring the first season of the recovery where earnings miss more than beat estimates?

In our opinion the dollar has held it's ground fairly well over the past month and may see a short term appreciation on interest rate concerns, while we view crude oil as overbought and due for a pullback. We follow the Moving Average Convergence Divergence technical series, as it has been highly predictive of price cycles in the many securities, mainly crude oil, over the course of the recovery, and see crude oil particularly overbought with respect to this statistic.

Whether earnings season is a make or a break for stocks relies on more than the results of just one firm, yet the manufacturing recovery story has remained the golden goose of 2009 and will not benefit from the implications derived from a negative AA earnings card.

Disclosure: Author holds long positions in DTO, SDS, SCC