Aug 1, 2019

News | Stealth Indicator Signals Bad News As Fed Cuts Rates

By Mark Kolakowski

Leading U.S. machinery manufacturers have missed analysts' estimates for revenues and earnings due to the strong dollar, weakening global economies and trade disputes, a troubling sign for the broader U.S. economy, Barron's reports. These companies include Eaton Corp. PLC (ETN), a conglomerate officially domiciled in Ireland which makes truck parts and electrical products, AGCO Corp. (AGCO), a tractor company, Cummins (CMI), a leading maker of engines, Terex Corp. (TEX), a crane manufacturer, and Caterpillar Inc. (CAT), a leading maker of heavy construction equipment.
As a group, these 5 companies missed 2Q 2019 consensus estimates by 1.3% for sales and by 4.1% for earnings, per Barron's. Adding to the gloom, Cummins, Terex, and Caterpillar also reduced their corporate guidance for the rest of 2019. AGCO raised its guidance, while Eaton held its steady, Barron's adds.

Significance for Investors

The strong U.S. dollar has hurt all five companies, by raising the price of exports in local currencies and by translating overseas earnings into fewer dollars. For example, the strong dollar reduced 2Q revenue for AGCO by 5.7%, Barron's indicates.
All else equal, lower interest rates in the U.S. should weaken the dollar. The announcement by the Federal Reserve on July 31 that it would cut the federal funds rate by 25 basis points (bp) thus should be a modest positive for these stocks going forward.
However, global growth in manufacturing has been decelerating since Dec. 2017, Barron's notes, creating a more serious headwind for these stocks. Eaton's 2Q sales of hydraulic equipment or lifting and towing heavy objects have slowed. Terex faces lower demand for the aerial work platforms used for building and maintaining tall structures. Cummins and Caterpillar have been hit by weak demand from the oil and gas industry. AGCO saw net sales drop by 4.5% year-over-year, per its earnings release.
For Caterpillar, 2Q revenues were up by 3% and EPS by 1 cent on a year-over-year (YOY) basis, per The Wall Street Journal. However, they missed the consensus estimates by 2.8% and 9.3%, respectively. Sales in Asia were down by 8% due to competitive pricing pressures and a Chinese holiday, but sales in the U.S. and Canada were up by 11%, as strong demand from mining companies and from state and local governments for infrastructure projects more than offset weak demand from energy exploration companies in the Permian Basin and from home builders.
U.S. tariffs on imported steel and aluminum cost Caterpillar $70 million in both 1Q and 2Q 2019, and the company projects a full year cost between $250 million and $300 million, versus $110 million in 2018, per the Journal. However, Caterpillar has raised prices, which added $427 million to operating profit in the quarter. Nonetheless, Caterpillar now expects EPS for full year 2019 to be near the low end of its previously-indicated range of $12.06 to $13.06, the Journal notes.

Looking Ahead

Mike Wilson, chief U.S. equity strategist and chief investment officer (CIO) at Morgan Stanley, warns that future consensus earnings estimates are too high by about 5% to 10% and expects a 10% market correction in the next three months, with the S&P 500 eventually ending 2019 at 2,750, or 7.7% below the close on July 31, per Barron's.
Wilson finds that negative corporate guidance about future earnings is at a three-year high, Business Insider reports. He also observes that cautious investors have made defensive stocks market leaders, and sees weak market breadth as indicative of deteriorating prospects for most stocks.

Source: Investopedia

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