Sunday, October 21, 2007

Wasn’t the First, Won’t Be the Last



Caterpillar Pulls Economic Alarm

Sectors Likely to Weaken; Outlook for '07 Is CutDespite 21% Profit Rise
—Wall Street Journal, October 20, 2007.



Whatever the real reason for Friday’s stock market relapse, the press needs somebody or something to blame.

So they are holding Caterpillar, the American icon that guided earnings modestly lower and made some discouraging comments regarding the state of its U.S. business, to blame.

Caterpillar Inc.'s gloomy forecast for the North American economy and its lowered full-year profit outlook overshadowed its record third-quarter profit and cast a pall over many sectors.

Caterpillar, like many other U.S. manufacturers, has increasingly relied on its global footprint to generate business at a time of increasing uncertainty about the health of the U.S. economy, but its bleak comments signaled that this strategy can only go so far.
—The Wall Street Journal


Now, you might think the $300 billion of frozen LBO commitments rotting a hole in the erstwhile large pockets of America’s investment banks might have given pause to investors eagerly bidding up stock prices in the wake of the Fed’s surprisingly large rate cut one month ago.

You might also think those buyers chasing stocks at all-time highs would have felt a slight tinge of buyer’s remorse due to the fact that the nation’s largest single engine of growth—the housing market—has frozen and left millions of plain old Americans as hard up for liquidity as the leveraged buyout stars of Henry Kravitz’s self-proclaimed “Golden Era” of Private Equity.

And, of course, you might have thought the frantic efforts of Citibank to find a clever way to liquify the $80 billion in Structure Investment Vehicles rotting a hole in its off-balance sheet balance sheet would have given eager stock-buyers pause prior to Friday.

But in all three cases you’d be wrong.

Those buyers chasing stocks at their very all-time highs were not dissuaded by the recent, discouraging past or even the ugly present.

They were, it seems, looking to the future, as they have learned to do thanks to the lessons learned from years of absorbing the Greenspan Method of Driving the Federal Reserve Bus, which Mr. Bernanke apparently studied quite assiduously.

The Greenspan Method of Driving, as near as I can tell, involved putting the pedal to the metal whenever the risk of a slowdown was somewhere on the general horizon...which, in the case of Greenspan, seemed to have been painted onto his eyeglasses by some clever Fed staffer, so long did he leave his foot on the gas after the economy had gone into overdrive.

But Caterpillar was not the first company to warn that “What Happens in Sub-Prime Is No Longer Staying in Sub-Prime.” (See “What Happens in Sub-prime…Gets to Spain Really Quickly,” from August 6, 2007.)

Earlier in the week, Illinois ToolWorks—which makes everything from arc welders to simple hose clamps—reported seeing “a noticeable slowing in North America” in September.

That came on top of a previously reported “slowing” in the general industrial market which ITW discussed three months ago on its second quarter earnings call.

Did I mention that was three months ago?

Another fairly important data point—not that anybody was paying attention until Friday—came Wednesday when Manpower, which happens to be the world’s largest employment agency, likewise commented on the U.S. slowdown:

We continue to see positive revenue trends in most places, though in some places like the U.S. we are seeing softness….

If you look closely at the quarter we didn't see any dramatic deterioration during the quarter. We also really didn't get a lot of encouragement. I guess I could put that as good news, because we are not seeing it really slide any more. We had a first few weeks that we started out in the quarter were slow as we anticipated, but we didn't see that typical seasonal pick-up that we would be getting in September and October. Our clients aren't desperate, but there is a high level of cautiousness…

But even Manpower’s commentary should have been no surprise to anybody paying even a tiny bit of attention to news from the field prior to last week.

As far back as the first week of September, Office Depot CEO Steve Odland discussed in plain language why 'What Happens in Sub-Prime Is Not Staying in Sub-Prime,' while responsing to a question regarding the company’s disappointing sales and earnings outlook:

Yes, a lot of these small business -- a lot of our customers -- most of them are nine employees or under. A lot of them are on the very small end of that, so they have a few employees. So you see contractors, you see real estate agents, you see the tradespeople and so forth. A lot of them are home offices, or they're working out of a shop and so forth. So they don't tend to use conventional sources of financing.

We have heard a lot about financing of very small businesses in the last quarter or so. But the customers that are in the SIC codes related to the housing market have seen significant double-digit decline themselves. So we have a significant number of customers who fall into these SIC codes. We are seeing the purchasing from those customers down very significantly as well. So every cut of this analysis seems to be pointing to the same thing.


Unlike Office Depot, until Friday Wall Street didn’t see much of anything but blue skies and trees growing to those skies.

So go ahead and blame the wake-up call on Caterpillar, if you like...but Caterpillar wasn't the first company in America to see business hit the brakes.

And it probably won't be the last.



Jeff Matthews
I Am Not Making This Up

© 2007 NotMakingThisUp, LLC

The content contained in this blog represents the opinions of Mr. Matthews. Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews' recommendations. This commentary in no way constitutes a solicitation of business or investment advice. It is intended solely for the entertainment of the reader, and the author.

7 comments:

whydibuy said...

But why the sudden epiphany???? The housing crash and the ensueing slowdown has been happening since at least last fall. I think whats incredible is how wall street guys totally missed the elephant in the living room. Its not only in the living room but its dead and starting to rot. Apparently they still don't see it but are now questioning where that bad smell is coming from. Even today, Ben Stein was once again extolling on the virtues of the economy. Employment is nearly full, interest rates are low, the vast majority of mortgages are current and the stock market is near all time highs. The only thing he missed was the enormous boost the economy got from the mortgage boom, equity extraction binge and all its positive ramifications on the economy that are now receding month by month. For some strange reason these guys cannot see the forest for the trees. Incredible.

Harleydog said...

Jeff,
Enjoy your posts. How's the saying go... it's not a problem until its a problem. Autonation Michael Jactkson complained of housing's effects back on July 26 which were ignored by the media and investors. Link to comments is below

http://www.cnbc.com/id/19969870/

AlexT said...

Funny no one picked up the announcement from Logitech that they lost $80mn on SIVs and fired their CFO.

Just wondering if we will see more losses from non-banking companies...

super ultra said...

Is it possible that what investors are seeing is the switch from an US-dominant economy to an economy where emerging markets are not dependant anymore on the IMF/world bank handing out money, neither the US buying much of their production? That would explain US exporters stocks going higher, while non-transable products companies being flatter

Aaron said...

Jeff: Another company that is seeing the effects of sub-prime is AXP. In today's WSJ, AXP reported a 44% rise in loan-loss provisions for potential write-offs and delinquencies, despite a 32% increase in revenue from its international card services.

I wonder whether that's the result of US consumers being "tapped out" from spending what's left of their available home equity and shift their spending to credit cards?

I also wonder whether a slowdown in US consumer spending portends slowing future earnings growth for credit card companies (hello, COF)?

I could be wrong, though...

robcyran said...

OT- but maybe you will find this comment from a research report as helpful as I did.

WellCare, an HMO, was raided by 200+ FBI agents, agents from Florida's Medicare fraud division and inspectors from Health and Human Services.

Deutsche Bank's take - "Investors are likely to re-visit their approach to valuation of WCG in the near-term given the news of the FBI raid."

Liz said...

I have lost all respect for Mr. Greenspan. It was under his watch that the ginormous glut of liquidity was created, and now he stands on the sidelines and makes catcalls at the excesses that he himself created. As Paul Volcker once said "It is our job to take away the punch bowl just when the party is getting good." And after Mr. Volcker left, you never heard from him again.