Caterpillar's Warning: What It Means for Your Stocks

By Sasha Cekerevac for Investment Contrarians

One of the most worrying signs from the latest batch of economic data is that the global recession might be reappearing. Central banks around the world have been attempting to fuel their economies through massive stimulus, yet these efforts appear to be failing.

Increasingly, the earnings outlook for a number of companies continues to be quite poor for the remainder of the year. This is giving me pause for thought, because these poor outlooks raise the chances that another global recession will occur.

Last week’s data from the Conference Board Leading Economic Index for the U.S. indicated a drop in March. This was the first drop in seven months—certainly a negative move away from the chance of averting another global recession.

More importantly, the Conference Board’s outlook for the next three to six months dropped 0.1% in March, below the median forecast by a survey conducted by Bloomberg. (Source: Smialek, J., et al., “Leading Index’s Drop Points to Slower U.S. Growth: Economy,” Bloomberg, April 18, 2013.)

Manufacturing also declined, as indicated by the Federal Reserve Bank of Philadelphia reporting that its factory index dropped to 1.3 in April from 2.0 in March. (Source: “March’s Coincident Indexes Show Increased Economic Activity in 47 States,” Federal Reserve Bank of Philadelphia web site, last accessed April 23, 2013.) This was a significant reversal from the median forecast, in which expectations were for the index to rise to 3.0.

How does this affect the earnings outlook for corporations? Many companies have been expecting that the global recession could be averted, as each company’s revenue and earnings outlook last fall was fairly positive for 2013. It now appears that the earnings outlook for many companies is being downgraded significantly because economic weakness is still prevalent.

One example is Caterpillar Inc. (NYSE/CAT), which disappointed in its first-quarter earnings and lowered its earnings outlook for 2013. Caterpillar announced an earnings outlook for fiscal 2013 of approximately $7.00 per share, in the lower part of the range of previous estimates of $7.00–$9.00 announced just this past January. (Source: “Caterpillar Reports First-Quarter Results, Revises Outlook and Announces Resumption of Stock Repurchase,” Caterpillar Inc. web site, April 22, 2013.)

Caterpillar has also lowered its sales guidance for the duration of 2013 to the range of $57.0–$61.0 billion, down from $60.0–$68.0 billion. One reason for the decrease in its revenue and earnings outlook is that the global recession is weighing heavily on mining stocks. Mining companies are incurring huge cost increases as commodity prices drop precipitously—a bad combination and one that will most likely result in additional decreases to the earnings outlook for those firms in 2013.

The drop in the price of many commodities is causing mining stocks to retrench and cut costs, including those for expansion plans. This is hurting companies, such as Caterpillar, that had been hoping the global recession could be averted and commodity prices could gain pricing strength.

Caterpillar’s 10-year stock chart is featured below:

This 10-year chart shows that while the stock has recently retrenched, it could still drop significantly lower if the global recession worsens. While the firm’s earnings outlook has decreased substantially, if the global recession were to accelerate in its decline, we could see a drastic drop in the share price for Caterpillar and many other companies that rely on economic growth.

At this point, I would certainly urge caution for investors in companies such as Caterpillar. Until we see evidence that the global recession will be averted, the earnings outlook for many commodity-related companies could continue to be revised downward. It appears we are at a crucial crossroad, and from here I would need to see further data showing that the global recession will be avoided before considering accumulating economically sensitive stocks. Until that point, a company such as Caterpillar could see additional selling pressure for much of this year.

This Article Caterpillar’s Warning: What It Means for Your Stocks was originally published at Investment Contrarians