Wednesday, April 11, 2012

We ask again: Is Alcoa the Bellwether of the Economy?

Alcoa (AA), the aluminum manufacturer that many refer to as the bellwether of the U.S. economy, reported better than expected Q1 earnings. This will be taken as good news by the market, at least early on. We decided to do some back-of-the-envelope calculation to see if this 'bellwether' reputation has any merit. As usual, our analysis was not very complicated.

If one is talking about AA's quarterly performance being an economic indicator, then sales growth is what one must look at. The Company's 70% Y/Y decline in earnings, although it beat the very credible Street's estimates, certainly should not be considered a good economic growth indicator. For this reason, we focused on the Company's sales growth.

We first looked at the correlation of AA's top-line growth and U.S. GDP growth. Not surprisingly, the two are positively correlated. The figure, based on 13 years of quarterly data, was approx. 0.60.

We then regressed annualized GDP growth per quarter against AA's sales growth. It turns out that a 1% AA quarterly sales growth represents an increase in US GDP growth of only 20bps. We must say that the AA sales coefficient turned out to be statistically significant, explaining 33% of the variation in GDP growth. However, based on this very complicated & simple linear regression (!), AA Q1 sales growth indicates only a 1.9% Q1 GDP growth, significantly below 2.4% which is the midpoint of economists' estimates ranging between 2.2% and 2.6%.

For this reason, if AA's performance is a bellwether of the economy, then maybe we should not be overly optimistic about Q1 economic growth.  In addition, maybe the higher Feb. wholesale inventories reported on Monday were due to lack of sales rather than higher projected sales.  Or as we have been before, we can remain a bit hesitant in viewing AA quarterly results as a bellwether for the U.S. economy. Of course, after the market's (S&P 500) 4.3% decline over the last five trading days, we do expect AA's better than expected earnings to have a positive impact, but we doubt such impact will last long.

Regarding the Company’s quarterly earnings presentation, its 2012 end-market guidance calls for strong growth in North American automotive and heavy trucks markets, partially offset by weakness in the beverage can industry, and commercial building and construction. The only bright spot that AA sees in Europe is the beverage can packaging end-market, in which AA expects a 5% - 7% growth this year. For China, the Company lowered its growth projections of the automotive and trucking industries, while it slightly upped growth forecast for commercial building and construction.


After hitting levels to which we referred as fair value, S&P 500 has already broken below the two support levels that we mentioned before, 1390 and 1375; and it is not too far away from 1350. It will likely remain between 1350 and 1365 until the important PPI and CPI figures are released on Thursday and Friday, respectively (in addition to the initial jobless claims). We note that the 1350 level can be considered very important as the S&P 500 hit that level and went slightly above it multiple times in 2011 before beginning its near 19% correction phase in Aug. '11. The 1300 level, or another 4% decline, could become more probable if that 1350 support level is broken through.

Lastly, we must note that Bernanke did not mention further quantitative easing on Monday night. The market is beginning to discount any probability of further easing after June, which also explains the latest pullback.

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