Caterpillar Ignites Fear for Equipment Stocks

Equipment stocks showed their true colors Wednesday (04/25), failing to keep pace with the major market indices…
While Apple’s positive earnings announcement sent the bulls into a buying frenzy, the major equipment stocks failed to show up at the party.  Bearish action in an otherwise positive environment is definitely a red flag worth digging into (no pun intended)…
There were two primary catalysts that drove equipment stocks lower.

• The first quarter earnings report for CAT failed to live up to expectations.

• The durable goods report turned out to be the weakest reading in a number of years.

First, the earnings announcement from CAT.  On the surface, the report was fairly positive.  Q1 EPS rose 29% over last year due to strong domestic sales and healthy demand from mining equipment.
Management even raised full-year guidance – although not as much as Wall Street was expecting.  Instead of focusing on the strong quarter and higher guidance, investors worried about weakening demand in China, Brazil and Europe – and dumped the stock on heavy volume.

Via the WSJ:
Chinese buying of construction equipment has plunged since the middle of last year as higher interest rates, have discouraged spending on machinery and building projects.
But Caterpillar expects Chinese demand to recover in the next few years.
Since the real opportunity for equipment makers is heavily weighted towards potential sales from China and India, a disappointing picture for emerging markets is certainly cause for concern.
This falls in line with our Gray Swans thesis – as a confluence of bearish macro-economic catalysts challenge the Goldilocks growth scenario.  Decelerating growth in China and austerity measures in Europe can’t help but dampen global demand for capital-intensive equipment.
But what about domestic sales?  This was an area of strength right?
Caterpillar may have reported a strong sales of construction equipment in the US, but yesterday’s durable goods report was much less optimistic.
For the month of March, durable goods orders declined by 4.2% – the largest drop since January 2009.  And just for good measure, the Commerce Department revised the February report lower – so March’s decline was actually worse than the headline number indicated!
Once more from the WSJ:
Wednesday’s durable-goods report followed a string of weaker regional manufacturing reports as well as industrial-production data that showed manufacturing production fell slightly in February, despite strength in several areas including vehicle and parts manufacturing…
Indeed, while new orders for durable goods slipped over the month, shipments were up. That means the slowdown in manufacturing, if it continues, is likely to take a bite out of second-quarter growth. The shipment figures, in fact, prompted economists at Morgan Stanley to boost their forecast for first-quarter gross domestic product to annualized growth of 2.9% compared with 2.7% before the report.
While the CAT may already be out of the bag (ok, that was really bad…), we’ve got our eye on a number of equipment makers that have bearish or weakening chart patterns along with fundamental vulnerabilities.
All of our trades are time stamped and reported in real time via the Mercenary Live Feed.

• Cummins Inc. (CMI) has a focus on diesel and natural gas engines, and relationships with OEMs who are selling directly to domestic and emerging market end-users.  The stock broke to a new high in February – but ran into overhead resistance and broke down.  CMI pays a 1.4% dividend yield (creating a negative-carry short position), but looks technically vulnerable in an industry that is under pressure.

• Deere & Co. (DE) manufactures equipment for agricultural as well as construction markets and is expected to grow earnings by 21% this year.  A heavy debt load (249% debt to equity) makes for a vulnerable financial situation, and the stock dropped sharply this month after a crop report hit corn prices hard.  With significant overhead resistance, DE shares should have difficulty trading higher, and there is plenty of room below before hitting significant support.

• Joy Global (JOY) sports one of the better growth rates (expectations for 30% EPS growth in 2012), but analysts have been revising their models lower as the economic picture deteriorates.  The stock has been underperforming its peer group this year (see chart above) and has established a predictable bearish pattern.  JOY is set to announce Q2 earnings on May 31 (fiscal year end Oct 31), and for now the stock is trading in-line with the increasingly bearish industry.

• United Technologies (UTX) has been under pressure due to low revenue and earnings growth.  For the first quarter, UTX logged a 2% decline in revenue, but cut costs enough to manufacture a 2% bump over last year.  The stock peaked in March and has been trading below the key 50 EMA since the beginning of April.  With earnings now out of the way, there are few catalysts that would send this stock higher, and plenty of vulnerability based on economic headline risk and industry trends.