Caterpillar came in with a huge upside surprise on its earnings today.
And that has people worried.
How on earth is it possible that domestic sales of construction equipment could have increased 92 percent?
Construction is recovering—but it is not anywhere near the level that could justify that kind of spending on equipment.
This shouldn’t really be a boom time for Caterpillar.
Even Caterpillar’s executives seem surprised. According to Caterpillar, rental dealers have rapidly increased their buying to replace aging equipment. This is essentially how Caterpillar’s competitors also explain their rising sales.
As Joe Weisenthal of Business Insider points out, the company [CAT 115.41 2.77 (+2.46%) ] is essentially explaining that dealers are buying in anticipation of a recovery that hasn’t happened yet.
What makes this troubling is that it has the basic markings of credit driven bubble. According to business-cycle theory, extended periods of artificially low interest rates induce businessmen to make long-term investments on the mistaken assumption that the low interest rates represents real savings in the economy. But because those excess savings don’t exist, the investments eventually go sour.
The worry is that companies that rent out construction equipment may be making this classic credit bubble mistake.
Caterpillar, for its part, doesn’t think that’s happening.
“Let's be clear, though, we do not think this is any kind of a bubble,” a Caterpillar executive said on its conference call.
Of course, when executives deny bubbles in the markets relevant to their companies, that’s not always a good sign. There were plenty of real estate people who denied we were in a housing bubble—right up to the moment it burst.
CAT: Here's the weekly chart on CAT. It's up 5 fold from the recession low. The weekly MACD is wildly over bought, but with no divergences in place on either the RSI or MACD it could easily have more upside. What makes sense from the technical view would be a correctional phase to burn off being over bought technically and then another rally to create exhaustion or a topping pattern. Then maybe a larger correctional phase.
Would I buy it now? No. It's had a monster run and due, over due for some kind of correctional phase. I'd want to see how that unfolded first. If I owned it, I would think about gain protection strategies now. You're three choices are selling the stock in part or entirely, using stops, or writing and selling call options against your position.
Back to the Economy!
Their domestic construction equipment sales are up 92%. That's huge to say the least.
Most of my clients are contractors of some kind, mostly sub contractors. I see better gross revenues so far this year than last year for most of my clients. Especially those tied in to stimulus money or those tied into the building of large multifamily buildings or public works projects. That's where the business is for the most part. But the growth I've seen in those segments by no means justifies 92% growth.
If it's truly rental companies replacing old equipment that could be a one time sales event to some degree. In that, if these companies finish a cycle of replacing old equipment and the economy does not continue to strengthen, why are CATs sales going to improve domestically? In fact, shouldn't we expect a decline once the replacement cycle stops?
It's cheaper to rent than own!
In the real estate market, in many locations it's cheaper to rent than own and that has been an indication of an over valued real estate market in the recent past.
The same thing could be happening here and an indication of CAT and the economy as a whole. If contractors do not see enough growth or business to buy equipment, than it's cheaper for them to rent it from a rental company compared to owning it themselves.
It suggests the economy has truly not improved enough for that kind of capital expenditure, and that the improvements we have are viewed as minimal or temporary by contractors. What happens when stimulus money is no longer there or governments trim spending budgets? What happens when the cycle of multifamily building ends? If the economy doesn't gain traction, CATs domestic sales to contractors and rental companies could decline. That's bad for CAT but also a great indication of economic health!
Hope all is well.
J.D. Rosendahl, Rosey