What Caterpillar’s Earnings Mean For The Economy & For You
Tuesday, April 21, 2009
by Karim Rahemtulla, Investment Director, Smart Profits Report
This morning, Caterpillar (NYSE: CAT), the world’s largest manufacturer of construction equipment, reported its first quarterly earnings loss since 1992 - a drop of $112 million ($0.19 per share) on a 22% sales slump, versus a $922 million ($1.45 per share) profit a year ago.
While the news was hardly unexpected, it clearly tells us that this downturn will continue well into 2010. Heavy equipment sales are a leading indicator for future growth - and there is no better barometer than Caterpillar.
The company’s words and actions illustrate that. Citing a “high degree of uncertainty” about the global economy, CEO Jim Owens stated that, “It’s extremely difficult to know how our customers will respond during the remainder of 2009.”
As a result, Caterpillar slashed its full-year sales forecast to between $31.5 billion and $38.5 billion ($1.25 per share) - down from its $36-44 billion ($2.50 per share) projection just three months ago. Even if sales hit the middle of that range, it would be a 32% plunge from 2008 - the firm’s worst year since the 1930s, according to Reuters.
What does this harbinger mean for you? A lot…
The Leading Economic Indicators Are Looking Shaky
News like this means you should still keep some buying powder dry, because this market is likely to trade lower or stay range-bound for a while.
“But, Karim” (I hear you ask), “… haven’t you said before that the market is a forward-looking indicator that reacts 6-9 months before the economy turns?”
Yes, that’s true. This mechanism has proven itself time and again, without fail - and it’s still intact. But the current rally is not showing signs of the definitive move that we’re looking for.
Yesterday, for example, the Leading Economic Indicators index (LEI) moved lower. The LEI measures economic activity and projects activity by six months or so. It fell after rising the month before.
And two other sectors are struggling, too…
Energy And Raw Materials: Two Key Econo-Growth Sectors Under Pressure
When we’re talking about robust economic growth, two sectors that spring to mind as key drivers are energy and raw materials.
Companies within these sectors have a much better feel for the short-term economic pulse than conventional companies. They live and die based on inventory management and future supply and demand projections, as well as costs.
But shares of companies in both sectors are under pressure. For example, most integrated oil companies have slashed their sales and earnings estimates, with BP (NYSE: BP), Sunoco (NYSE: SUN) and Chevron (NYSE: CVX) currently trading near their 52-week lows, despite oil prices being higher now than two months ago.
And raw materials companies like Freeport McMoran (NYSE: FCX), a major copper and gold producer, and a winning pick in my LEAPS portfolio, have seen noticeable near-term weakness in share price.
So it’s all doom and gloom, right?
Nope. Despite the bad news - and contrary to what you might hear from the mainstream financial media - there is money to be made.
And you can do so by adapting your portfolio to the market’s new reality…
Sell… Sell… Sell! But Not In The Way Cramer Wants You To
That new reality means you should position yourself as a seller, not a buyer.
But not a frantic, head-for-the-exits seller of stocks… a seller of options.
As I scan our portfolios, the two most effective investment strategies at the moment are:
- Selling Covered Calls: Raking in money from the high premiums that exist as a result of above-average market volatility.
- Selling Put Options: Getting paid to buy stocks at the price you want - again, thanks to volatility.
The covered call strategy works particularly well because you can accomplish two things:
- Own the stock and position yourself for a sustained recovery in share prices.
- Use volatility to make money while you wait.
And because of higher volatility, you can get fat premiums from selling calls that are quite far out-of-the-money.
Let’s take a company I mentioned a moment ago as an example - Freeport McMoran…
Take A “LEAP”… Bag Some Cash
At the moment, you can sell the August 2009 (about 120 days from expiration) $60 calls for around $1.20 a contract.
To get your shares called away, Freeport would have to increase by more than 50% from current levels. Of course, a high option premium like this implies that Freeport has a decent chance to make that target.
In this regard, a Freeport LEAP option would also make sense. LEAPS are long-term options that allow you to participate in the rise and fall of share prices at a fraction of the cost of owning the actual shares.
In this case, you’d sell a Freeport LEAP put option to collect the fat premiums and position yourself to own Freeport at a lower price, thus combining a put strategy with a LEAP strategy.
Regardless of which strategy you follow - and we have explanations for all of them in our free Smart Profits Report archives - the worst decision you can make right now is to do nothing while the market is begging you to take advantage of its schizophrenic behavior.
Karim Rahemtulla
P.S. Feel free to browse our archives at your leisure to see what strategy fits your investment style. If you find something to your liking, hop on over to our trading center, where you’ll find quick rundowns on how all our trading services work. We have ones for covered call selling, LEAPS, put option selling, and more.
Related Articles:
Two Ways To Make Money From Market Volatility
Kiss Goodbye To “Ordinary” Investing: Why Smart Investors Use Covered Calls
Put Option Selling: How To Buy Stocks At A Discount & Get Paid For It
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