Shares of select companies including Alcoa (AA) whose fortunes tend to rise and fall with commodities have been flogged this year. That’s because prices for everything grown or pulled from the ground have dropped steeply amid economic pullback and government action in China, weak fiscal trends in Japan and Europe, and a worldwide commodities glut that many industry analysts believe is still working its way through the pipeline.
Wall Street could be watching Alcoa’s unofficial kickoff to the heart of the Q3 earnings season today for a sense of China’s ongoing impact on U.S. multinationals. In fact, it’s one of the leading themes of this earnings round and traders wonder if the worst sting from China has yet to be felt in the stock market. For example, restaurant chain YUM Brands (YUM) in its results issued earlier this week warned of “unexpected headwinds” in China and cut its full-year earnings outlook. Some industry analysts think Q3 could be the weakest reporting season in six years for S&P 500 (SPX) companies. Has the market fully braced for this potential outcome?
Industry analysts believe AA could turn in its first year-over-year profit decline in six quarters when it releases results after the closing bell. It has coped with about a 20% drop in aluminum prices compared with the year-ago period ending in September. Analysts reporting to Thomson Reuters are anticipating that per-share earnings will come in at $0.14, down 55% on a year-over-year basis. They peg revenues at $5.69 billion, which would be off 9% from the year-ago period. AA has typically beat earnings expectations—in 12 out of 13 quarters, in fact— but missed last quarter.
China is the largest exporter of aluminum, according to global trade statistics, and thus competes against Alcoa’s business. But a drop in demand for many products that are created using Alcoa’s alumina is impacting demand for the base metal, industry analysts say. Last quarter, the company reduced full-year 2015 and 2016 projections by approximately 20%. The stock has followed suit, falling 40% year to date (figure 1).
As for Alcoa stock, short-term options traders have priced in a 6.5% share move in either direction around the earnings release, according to activity tracked on the new-look thinkorswim® platform.
Current implied volatility in AA options is at 61%, running near its recent readings. Action in put option trading is at 2.5 times the typical volume today. Put options represent the right, but not the obligation, to sell the underlying security at a predetermined price and over a set period of time.