Stock Futures are Relatively Flat as Investors Focus on Bonds Ahead of the New Earnings Season

Bond investors got back from holiday and in a buying mood. However, stock investors appear to be hesitant ahead of a new earnings season. Value investors are shopping among the Chinese stocks for some potential fallen angels. But the Energy and Materials sectors are still garnering much off the attention.

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5 min read
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Key Takeaways

  • Stock Investors Gearing Up for a New Earnings Season 
  • Analyzing Fixed and Variable Costs in the Energy Sector

  • Rising Oil Prices Can Be Positive or Negative for Other Industry Groups

(Tuesday Market Open) Bond traders are back to work on Tuesday after taking Monday off for Columbus Day. Bonds are trading higher this morning as yields are falling slightly. Lower yields could pull financial stocks lower on the day. However, stock traders appear to be hesitant to commit one way or another as stock futures are relatively flat in front of a new earnings season that expected to kick off on Wednesday.

One earnings announcement that is out on Tuesday morning is Fastenal (FAST). The seller of nuts and bolts, tools, and supplies reported a 10% increase in sales but is also seeing cost increases. Fastenal did beat estimates, but its talk on rising costs has the stock trading slightly lower in premarket.

A few more stocks that are moving in premarket trading include GlaxoSmithKline (GSK) which was trading 2.85% higher after Barron’s reported that the company may have a suitor for its consumer goods division. MGM Resorts (MGM) was more than 2% higher after it was upgraded by Credit Suisse analysts with a price forecast at nearly twice its current price. And, Merck (MRK) was up about 1% as yesterday’s momentum on the news that it requested an emergency authorization its new COVID-19 pill appears to be spilling over.

Despite trader hesitancy, some investors appear to be looking for value. Chinese stocks have benefited from the value shoppers. Alibaba (BABA) is up 24%, Tencent (TCEHY) is up more than 9%, and JD (JD) is up about 14% from their October lows.

The job openings or JOLTS report will be released after the open. Analysts are expecting another increase in job openings. However, job openings haven’t been the problem. It’s finding people to fill the positions that has been a problem.  

Stocks started the week on a relatively flat note with the bond market closed and many investors appeared to be a little guarded ahead of a full calendar this Wednesday. The calendar lists important announcements including the Consumer Price Index (CPI), FOMC Meeting Minutes, and the start of earnings season. However, investors were still moving a few stocks around on Monday.

One of these stocks was iron ore company Cleveland-Cliffs (CLF), which rallied nearly 4% on the news that it will be getting into the scrap metal business with the acquisition of Ferrous Processing and Trading. The Materials sector was the strongest on Monday, which saw some of its stocks boosted by higher iron ore prices.

JPMorgan analysts were active on Monday too. They reported high ratings for fintech firm SoFi (SOFI) and coffee brewer Dutch Bros (BROS). Both companies received an “overweight” rating. SoFi rallied almost 13%, while Dutch Bros was up 15%.

Drilling Down on Costs

Analysts have a tough job when it comes to projecting earnings. One projection they have to make is costs. There are two types of costs: fixed and variable. Fixed costs remain the same no matter the degree of output such as rent or mortgage payments. Variable costs change depending on the degree of output such as supplies and labor.

In industries like oil drilling, costs are quite prohibitive because they’re so capital intensive. These industries may need to increase fixed costs like buy land, buy equipment, write long-term labor contracts to specialists, and so on. As demand increases and more drilling is necessary, they may see variable costs rise as they add more hourly workers, rent additional equipment, deal with spills, and so forth.

Oil companies have some wells that are relatively low cost to run because they drill down to a reservoir and pull it out, while others like oil shale or sands may require more complex forms of drilling and are much more costly. When oil prices fell during the Russia-Saudi Arabia oil price war that aligned with COVID-19 lockdowns, many of these more expensive wells were shutdown. A study by BTU Analytics LLC found that about half of shale oil wells were profitable if oil prices were $40 per barrel. 

Today, oil prices are trading about $80 per barrel, which means more wells have likely come back online. According to Statista, Chevron (CVX), EOG Resources (EOG), ConocoPhillips (COP), Occidental Petroleum (OXY), and ExxonMobil (XOM) are the top shale oil producers. The top producers for oil sands include Suncor (SU), Canadian Natural Resources (CNQ), and Cenovus (CVE), along with the familiar names of ConocoPhillips and ExxonMobil.

JOLTS

CHART OF THE DAY: HOLDING PATTERN. Prior to the COVID-19 pandemic, the AMEX Airlines Index (XAL—candlestick) and oil prices (/CL—pink line) were mostly negatively correlated. During the recent recovery, the two have been positively correlated. Data Sources: ICE, S&P Dow Jones Indices. Chart source: The thinkorswim® platform. For illustrative purposes only. Past performance does not guarantee future results.

Fight or Flight: Rising oil prices translate to rising jet fuel costs. Last week’s A4A Passenger Airline Cost Index (PACI) showed that labor and fuel were the two largest expenses for airlines. This is one reason why oil prices and airline stocks used to be inversely correlated. In the 1990s, Southwest Airlines (LUV) started a jet-fuel-hedging program that helped them to successfully manage the cost of fuel through the Gulf War and the dot-com bubble. Southwest received a lot of acclaim for its cost control ingenuity, and since that time, most airlines have attempted to hedge their fuel costs.

The ability to hedge fuel costs is one reason why airlines are less negatively correlated to oil prices. While hedging can help lower fuel costs, eventually higher prices catch up.

Since COVID-19, airlines and fuel costs have risen together. In this case, it’s likely that the rising economic tide is raising all boats, meaning both are benefiting from the recovery. The airlines are just trying to get back to normal and has shown some success with increased bookings. However, the cost of fuel may eventually catch up and airlines could find more turbulence once again.  

Shovels & Pickaxes: During the 1849 California Gold Rush, people left home to try their hand at mining for gold. While very few people found wealth in “them thar hills,” many people found success selling shovels and pickaxes to the miners. In fact, pant maker Levi Strauss (LEVI) got its start selling pants to 49ers. Many investors find an important lesson in this bit of history, as sometimes the best investment is those selling to the diggers.

Some of the biggest oil and gas drilling equipment manufacturers include Halliburton (HAL), NOV (NOV), Baker Hughes (BKR), and Schlumberger (SLB). There’s also those that make the tanker trailers that haul the oil and gas like Teekay (TK), Euronav NV (EURN), Scorpio Tankers (STNG), Frontline (FRO), and DHT (DHT). Of course, there’s more than just drilling and hauling oil and gas, but it’d take forever to breakdown all the industries that could benefit from rising energy prices.  

Texas Tea: A few beverage companies that announced earnings last week have tapped into a bit of groundswell. PepsiCo (PEP), Constellation Brands (STZ), and Keurig Dr Pepper (KDP) are up more than 3.5%, 4.5%, and 7% from their respective earnings announcements. With the success of Dutch Bros, investors may find some appeal in the beverage industry.

While the Dow Jones U.S. Food & Beverage Index ($DJUSFB) is up almost 3% from its October low, it’s difficult to know if this is part of the recent rally or if investors are rotating into the Consumer Staples sector. The relative strength indicator for the Consumer Staples Select Sector Index ($IXR) compared to the S&P 500 shows the two indices have been moving together since late August. This is actually a stronger position for Consumer Staples, which has mostly underperformed the S&P 500 since March 2020.

Depending on which liquid you wish to tap, there may be another opportunity if you think about where it came from and how it gets to where it’s going.  

Good Trading, 

JJ

@TDAJJKinahan

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Key Takeaways

  • Stock Investors Gearing Up for a New Earnings Season 
  • Analyzing Fixed and Variable Costs in the Energy Sector

  • Rising Oil Prices Can Be Positive or Negative for Other Industry Groups

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