Earnings: CAT & HAL (Currency War)

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After last week’s sell-off, has the market hit a support level? From a technical aspect it looks like a decent level to start buying; however, I would caution on trying to pick a bottom and would suggest using options (spreads, married puts, ratios, etc) as a way to take a long position but limit downside exposure. We are still in the height of earnings season and there remain concerns in the global markets. Earnings reports have been a mixed bag, with some missing top line revenue even while beating the bottom line. Earnings beats on the bottom line works for this quarter, but with top line revenue declines, how will next quarter look?


Courtesy of wikipedia

Caterpillar (CAT)
If you have been following the Market Preview over the years you know that Caterpillar is a company I’ve had a fondness for since my childhood years. The company has faced many obstacles in the last few years, but has managed to continue to expand and focus on the emerging markets, which has helped carry the company forward as stagnation in the West has impacted growth. This morning CAT posted earnings that missed on both top-line and bottom line; however, the company has been forewarning of slower growth, so it doesn’t come as a complete surprise. We saw a huge boom in corporate growth in the emerging markets over the recent years and it was never expected that the growth at that pace would or could continue. Is the recent slow-down in growth because of actual fundamental problems in the emerging markets or has Caterpillar reached a saturation rate in which growth going forward is expected to be moderate? This is an important question as it defines the WHY and HOW. If there are fundamental economic problems in the emerging markets the company will have to do far more than just manage costs and it means a trickle-down effect for the entire sector.

The company posted earnings of $1.31 a share on $13.21 billion in revenue, down from $15.98 billion a year ago. Analysts expected a decline to $13.7 billion with $1.40 per share, missing both the top and bottom line. The company also revised its 2013 sales outlook to a range of $57 – $61 billion (previously at $60 – $68 billion) with earnings unchanged at $7-9 a share. The company reported that mining growth has slowed significantly, reducing growth demand for their mining equipment unit. Part of the problem has been a decline in ore prices. While still relatively high, they have come off in the last quarter.

The company, like many others, plans on managing costs and announced another round of lay-offs, 460 workers (about 11%), in their Illinois plant. The company had already shed 11,000 jobs a year ago. Meanwhile, growth in emerging markets factories and jobs continues to improve and the company now has over 23 factories in China. However, China is still a very competitive market, with Japanese Komatsu still dominating sales in the region by 3:1 over CAT. The company also had significant problems with a couple of plants in China, which impacted profits and revenue; hopefully the company has moved passed that. The company has also been expanding in Brazil and their South American unit continues to grow.

The stock has come off the $99 high in late January as the company continued to warn about slowing growth for the quarter and has declined to $80 per share. It seems like the earnings have already been priced into this stock. It looks like support around $80 and even with earnings this morning we see the stock is up in the pre-market. Is the worst behind CAT? A lot will depend on mining operations. The company, however, looks like it will be managing costs in order to meet their earnings goal for the year despite revenue. I would really like to see top-line revenue increases, rather than beating on the bottom line through cost cutting measures.

Courtsey of wikipedia

Halliburton (HAL)
Halliburton reported lower earnings and revenue, but expectations were for a far worse result. The company reported earnings of 67 cents on 6.97 billion, vs. 89 cents on 6.9 billion in revenue. Estimates were for 57 cents a share.

Part of the lowered expectation and concerns were based on some lawsuits and claims from the Macondo well explosion, which amounted to $828 million in claims from the disaster. The company included 637 million to increase its reserves against claims. North America continues to be a drag on the company with revenue falling 1%. The decline in the rig count of another 3% is not helping as regulations and limited permitting continue to limit energy growth in the Gulf of Mexico. The company managed to increase US margins by managing costs with more lay-offs and contract hiring. More than half of Halliburton’s revenue comes from the US, but that continues to shrink as international growth continues to expand. International revenue grew 21%, with the Asian sector up 51%. However, even with growth, net revenue for the company continues to decline from the $7.29 billion quarterly high in 2012 to $6.97 billion. The company continues to seek international growth to make up for declining revenues in the US.

The stock is up significantly in the pre-market because expectations for the slow-down in revenue growth, coupled with the Macondo settlement was expected to be far worse. The stock, similar to CAT, had come off the highs and is heading lower. The company failed to give future guidance, but expectations are similar to CAT, which the company continues to control costs (more lay-offs) in the US as they look to expand in the international markets.

The repeating theme in earnings is that top line revenue is declining. After looking at some of the biggest names reporting we see that growth remains centered in the emerging markets and while strong, it is not strong enough to offset stagnation and declines in the US and Europe. Halliburton, for example, still has over 50% of their revenue derived in the US, but the growth in the international markets is not strong enough to increase top-line revenue yet. The same is true for CAT and some other earnings we have seen.

Currency War impacts growth and earnings:

Companies continue to hire and build factories in South America, Africa and Asia where consumer growth continues to dominate. It was the emerging markets that helped save a vast majority of companies during the recession. We saw companies make a mad rush to the BRIC nations, going to where the consumer growth was as the US faltered and saw lay-offs and cost cutting.

No doubt (whether we agree or not) the Federal Reserve Policy and Government bailout and stimulus helped the US from slipping further and curtailed the hemorrhaging, but at what cost? The US consumer has not fully deleveraged and neither did the US business community. Instead we moved liabilities from the private sector (consumers/business) to the public sector (government) and have become so accustomed to the lifelines and stimulus that we have become dependent on it. The problem is that the US cannot recover until it deleverages. It doesn’t matter how much the government stimulates or the Fed prints, until that deleveraging happens we will remain dependent on government spending. The problem with stimulus is that in order to keep it going each successive stimulus has to be bigger than the one before.

Corporations are wise to this game and have been leaving the US in droves, going to where the consumers are and nations that are more friendly to business.

We are not seeing companies invest or hire in the US. In fact, we are seeing cost cutting and lay-offs from the big companies. The answer will be another massive round of government stimulus and even MORE Fed printing to “hopefully” get the US economy going. It’s just a LOT more of the same.

However, one can’t be confused to think that the US economy and the stock market (and companies) are intertwined; they are not. Companies, smart ones, will manage domestic costs and continue to expand where consumer growth is. For now that remains the BRIC nations. The question is can they expand fast enough to offset domestic stagnation and, more importantly, can they move fast enough?

My other concern is the currency war, which will certainly impact trade and the bottom line for many companies. Japan has gone off on a huge printing spree which is curtailing trade with the US. We continue to see companies like CAT having a difficult time competing with Japan’s Komatsu Ltd. Part of reason for that is the currency rate. Komatsu equipment is just going to be cheaper as Japan continues to devalue their currency. I suspect that the US will quickly follow suit and start printing even more.

It’s a race to the bottom (the most worthless and devalued currency), with Japan leading the way, followed by the US and then the Euro. At some point the emerging markets, predominately the BRICS, will start battling in this currency war as it affects their exports, unless their domestic growth becomes strong enough to off-set exports. I don’t see that happening, yet.

Support & Resistance

INDU 14,500
The pre-market futures are slightly higher, but I don’t know if that will remain strong. I expect a flat opening and some testing in this support range before making any significant move higher or lower.

NDX 2800
We are trying to move higher and all eyes will be on Apple (AAPL) which could inject a huge amount of volatility into the market tomorrow with earnings. I would look at the 2800 level as the straddle strike with a possible huge move higher or lower.

SPX 1550
The SPX is still holding in this support range, but that could change with Apple earnings tomorrow. I suspect that today the market will be in a holding pattern. The VIX has come off the 17 level and is at the 15 level. I doubt it will fall too much from here with Apple’s earnings tomorrow.

RUT 900
The broadest index continues to hold this very key level. It is this level that it needs to hold to confirm that order flow is not exiting the equity market. The 10-year yield is just above 1.7% this morning, but any scare in the equity markets could send the 10-year to 1.5%.

While I am not a buyer of treasuries, there can be a strong case for the bond prices to move higher (yield lower) as the job’s data, earnings, and domestic economic data, coupled with a very Dovish Fed could further push yields lower and ramp up their money printing to compete with Japan.

Bill Gross of Pimco (largest bond fund in the world), who had previously stated that one should limit their bond buying because of the very lower interest rates (negative real-return), is now Bullish. Not because of any fundamental reasons, but rather because he has heard the rhetoric from Janet Yellen (no. 2 at the Fed), knows the Fed governors are all Keynesian Doves, and sees that Japan is on a money printing spree that is weakening the Yen against the dollar. The only answer is that the Fed will respond with their own massive money printing scheme, bigger than QE3. This could force bond prices higher as the Fed buys them and sets the price, forcing yields down further.

He is not advocating buying bonds for yield; however, he is bullish based on bonds increasing in base price in the short-term. As a fixed income investment, they stink. As a bet on bond prices appreciating, well that is a different story. If Gross is right we’ll see the Fed fire off their broad-side against Japan in this currency war.

4 Responses to “Earnings: CAT & HAL (Currency War)”

  1. ck says:

    Hi Michael.

    I began following your blog a few weeks ago and got to learn a different perspective. Thank you.

    One recurring theme I’ve noticed in your blog is the stagnation and lackluster job market in the US. However, I just happened to learn that the H1B quota this year filled up already. In contrast, 2008, 2009 saw the H1B deadlines drag out to November due to few applications.

    H1B allows US employers to temporarily employ foreign workers in specialty occupations. There are application as well lawyer fees for each case submitted to INS. I think as a general rule, larger companies are more willing to do this for their foreign employees. So, in this case, wouldn’t the H1B status indicate some sort of recovery in the US economy (granted, these applications would be for people hired prior to March 2013)?

    • I am not sure if this reflects the health of the nation’s employment picture or even an improvement of unemployment. My humble opinion is based on the following:

      First the H1B visa is a small section (demographic) of the full national employment picture.
      Second the H1B visas are filling the need for specialized work, not typical labor, service, or manufacturing.

      Example, our software company is currently hiring programmers – we get many applicants from over-seas (H1B). Ironically (and sadly) they are far more knowledgeable and experienced than those we interview in the states. We would love to hire locally, if we could – but the talent pool for what we are looking for is limited domestically.

      I think the H1B visa is most likely a sign of the lack of specialized educated work force in this nation, rather than the actual employment/unemployment rate.

      I believe there is two levels of employment in this nation, highly skilled work force (in which if you qualify there is a well paid job) this is where the H1B are going. The other work force is the unskilled/lower skilled which is the vast majority of the work force in this nation, but fewer jobs available.

      I hope that helps clarify my view. Thanks for reading and your comment.

      • Let me also add – that all the major manufactures and banks have announced rather large planned layoffs. Bank of America, Citigroup, JP Morgan, CAT, Halliburton, and others – these announced lay-offs (as well as last quarter) are in the thousands, in some cases the 10s of thousands.

        However, the specialized/skilled force is still hiring, but I believe that is the minority of jobs available.

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