Chinks in The Armour of The Recovery Story

There are a few of chinks in the armour of the recovery story that are beginning to emerge.

A few earnings from a number of bellwether companies could be indicating to us that there are problems lying ahead with the macro economy.

Indeed, Caterpillar has just added to the growing list of US blue chip companies which have reported dismal earnings. They have just added to the growing number of Q4 earnings misses.

Caterpillar's Q4 earnings really don't give the bulls much to run about. The market was expecting Earnings Per Share (EPS) of $1.55, instead what we got was $1.35 in Q4 Adjusted EPS (and $1.23 on a GAAP basis). But if we were look to the future for guidance, which markets tend to do, then we start hearing the bears roar. 2015 sales and profit outlook has been slashed as follows:

“We expect world economic growth to only improve modestly in 2015. The relatively slow growth in the world economy and continued weakness in commodity prices—particularly oil, copper, coal and iron ore—are expected to be negative for our sales.” This reconciles with the World Banks recent estimate on world GDP which it forecasts will slow. Bearing this in mind, a further slide in commodity prices and the currency of commodity based economies is likely to continue its downward trajectory as we move forward.

It’s the last part of the statement that is concerning because it underscores the link between week commodity and oil prices and the negative impact this has on Caterpillar's sales

How could the two be linked?

Caterpillar offers heavy earth moving equipment, so when mining and construction falls, demand for the companies machines also drops. Falling commodity prices makes mining activities less profitable, it may even make some mines uneconomical to continue their activity. Moreover, with mining activity downsized, that means less demand for not only labour, but also mining machinery, the very kind that Caterpiller offers.

Similarly, the falling price of oil means less revenue for oil exporting economies, now means infrastructure and construction projects have been scaled back. Again this is having a negative impact on the sales for Caterpiller in those regions.

"The recent dramatic decline in the price of oil is the most significant reason for the year-over-year decline in our sales and revenues outlook. Current oil prices are a significant headwind for Energy & Transportation and negative for our construction business in the oil producing regions of the world. In addition, with lower prices for copper, coal and iron ore, we've reduced our expectations for sales of mining equipment. We've also lowered our expectations for construction equipment sales in China. While our market position in China has improved, 2015 expectations for the construction industry in China are lower," said Doug Oberhelman, Caterpiller's Chairman and CEO.

So we are now starting to see the secondary impact of the collapse in the super commodity cycle and oil deflation. This rationale would support the view that construction companies in the region are likely to miss their sales target going forward. That could offer traders with a short trade opportunity in construction companies in the region or any other business offering auxiliary services, such as the well drilling companies, engineering companies making the rigs and heavy moving equipment makers.

Procter and Gamble also highlights another macro-economic concern, but this time it’s a strong dollar story and how it’s creating headwinds on sales and reducing revenue and profit.

Procter and Gamble's recent results stood out with it missing revenue of $20.16Bn (est. $20.67Bn) and EPS of $1.06 (est. $1.13).

"The October - December 2014 quarter was a challenging one with unprecedented currency devaluations. Virtually every currency in the world devalued versus the U.S. dollar, with the Russian Ruble leading the way.”

"The outlook for the year will remain challenging. Foreign exchange will reduce fiscal 2015 sales by 5% and net earnings by 12%, or at least $1.4 billion after tax. We have and will continue to offset as much of this currency impact as we can through productivity driven cost savings. And we will continue to invest in our businesses, brands and product innovation, because it is the right thing to do for the mid- and long-term, while we deliver another year of strong cash returns to shareholders. We are adjusting fiscal year earnings targets accordingly,” said P&G CEO. When a CEO uses the words “challenging”, that means he envisages stormy waters ahead, which could trigger a string of lay-offs.

P&G highlights a macro-economic story, that the appreciation in the US dollar is hitting US company sales and revenue.

Bearing in mind the fall in global infrastructure investments, spurred on by low commodity and oil prices, coupled with a strong US dollar, which is choking US exports, I would not be surprised to see more poor US earnings going forward. That could pull US markets down further, unless of course we get QE4 to the rescue. Not an impossibility…