by Shawn Narancich, CFA
Vice President of Research
And They’re Off!
Wall Street’s quarterly rush of earnings began this week, taking the news baton from moribund economic data and the easy money policies of central banks worldwide. From money center banks Wells Fargo and JP Morgan came predictably strong earnings buoyed by 30 percent-plus gains in industry-wide mortgage volumes. Record low interest rates have incented the masses to refinance their mortgages and purchase homes, but falling interest rates are damaging net interest spreads at a time when the margin of error has been narrowed by strong gains in bank stock prices. Investors were left unimpressed. Wells Fargo and JP Morgan fell Friday, headlining a pullback for the financial sector that has led the stock market higher so far this year.
Outside of the big banks, several other names responded favorably to earnings reports, including fast food restaurant operator Yum Brands and industrial distributor Fastenal. The latter sold lots of nuts and bolts in the third quarter, enough to boost earnings by 12 percent at a time when weak industrial production and manufacturing numbers had steeled investors for much worse. In tech, perennial laggard AMD pre-announced weaker than expected earnings, citing the same weakness in PC markets that led Intel to pre-announce weaker earnings a month ago. All told, it’s too early to read much into the ultimate flavor of third quarter numbers. What we do know is that stocks gave back a couple percentage points this week while the benchmark 10-year Treasury bond rallied which now yields 1.6 percent.
Blue Burner
While energy cousin crude oil has largely marked time this year, natural gas has quietly built momentum heading into the winter heating season. Air conditioning demand has waned for the year, causing producers to inject more natural gas into underground caverns until demand for seasonal heating picks up. The so-called “shoulder season” might otherwise elicit shrugs by those claiming that there’s still too much gas behind pipes in North America, but this year is proving to be different.
Since its lows of around $2.00/Mcf in April, natural gas has rallied by 80 percent. Aside from seasonal ebbs and flows, what investors have witnessed this year is consistently robust year-over-year demand growth that has materially outstripped slowing supply gains. The key demand drivers are coal-to-gas switching (utilities substituting cheaper gas for more expensive coal to generate electricity), an unusually hot summer (boosting air conditioning usage), and the substitution of natural gas by chemical and fertilizer manufacturers (attracted by lower feedstock costs domestically).
Despite the gains for gas, most shale basins domestically still require prices substantially above the current $3.60 price to make new drilling economical. For oil projects, it’s another story entirely. At $113 per barrel, there’s no shortage of projects offering attractive rates of return, so energy companies are doing what’s in their best interest by shunning gas and embracing oil. Investors are doing just the opposite, sensing that a dearth of investment in natural gas is about to reverse the production gains that first brought the commodity to its knees.
Our Takeaways from the Week
- Stocks succumbed to profit taking as third quarter earnings season began
- Natural gas prices are rallying as waning supply gains are being more than offset by faster demand growth