Wednesday, October 12, 2011
With nothing major on the economic calendar today, the market will likely repeat Tuesday’s performance and remain in a wait-and-see mode for the earnings season to unfold. We had a fairly disappointing start to this reporting cycle on Tuesday, but no one is reading too much into Alcoa’s (AA) results. We have a handful of reports today, but it is still early going on the earnings front. By the end of next week, we should have a good idea of how this season is unfolding.
It is heartening to see that the market is able to see through the Slovak parliamentary failure and wait instead for the release of bank recapitalization rules from Germany and France later this month. A successful plan for ring-fencing the European banking sector will go a long way towards bringing down the heightenend contagion fears.
These fears, combined with a host of other issues, have been weighing on the financial services sector’s fortunes for some time. And as if the going wasn’t tough enough for the industry already, the announcement yesterday by U.S. regulators of the details of the long-awaited restrictions on proprietary trading, known as the Volcker Rule, adds to its woes. The new restrictions don’t come into effect till July 2012, but are aimed at reducing the industry’s risk profile. It will nevertheless have a material impact on the profitability of firms like J.P. Morgan (JPM), Morgan Stanley (MS), and Goldman Sachs (GS).
Estimates for the profitability impact of the new rule vary, but could be in excess of $2 billion in revenue loss for the major firms. That is a non-trivial amount given all profitability headwinds the industry is faced with at present. We are seeing evidence of those headwinds in earnings expectations for the financial services industry, which have come down the most of any other sector the last month or so. As would be expected, the industry is against the Volcker Rule and trying hard to soften it up. My personal disdain for excessive regulation notwithstanding, I am not opposed to the Volcker Rule. It is better to be safe than sorry and we all remember how sorry things had become in the fall of 2008.
On the earnings front, Alcoa (AA) dropped the ball, once again, coming short of expectations. This is not an encouraging start to the third quarter reporting cycle, but Alcoa’s results practically tell us nothing about what to expect from the rest of the pack. In other earnings releases this morning, Pepsi (PEP) came ahead of EPS expectations by penny on a solid revenue beat. The company did not provide firm guidance for 2012, but reiterated to the keep snacks and beverages firm integrated.
Host Hotels (HST), formerly known as Host Marriot, the largest hotel REIT in the country, modestly came short of expectations. But results at the largest hotel REIT firm in the country improved from the year-earlier level given improved occupancy and room rates.
We have seen quite a few strategic flip-flops from corporate America in recent days. Neflex’s (NFLX) recent moves are tailor made for business school case studies of what not to do. There is also word that tech titan Hewlett-Packard (HPQ) is having second thoughts about shedding its PC business as well.
Sheraz Mian
Director of Research
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