A seminal event this week could change the market's perspective about the economy, which in turn should affect the fund flows that have recently sought cyclical names like General Electric (GE). If events unfold as I suggest they could, I expect recently hot ideas like GE and Boeing (BA) would give way.
In a recent report, I suggested that there was a good chance the Federal Reserve would revise its GDP forecast lower this Wednesday when it publishes its quarterly update. I showed that the trend for the Fed over the last two quarters has been one of adjustment lower, but that it appeared its revisions were understated. The reasoning for this was due to comparison with the forecasts of the Conference Board and the World Bank, which were a half point or more lower than the Fed's current forecast range. Also, the Fed does not seem to have factored into its estimates the 1.5% impact that the Congressional Budget Office and Chairman Bernanke suggest should come from the Sequester spending cuts and expiration of the payroll tax break. See the report for further detail.
The Fed's inflated forecast has served to fuel the market. So that when the air comes out of its outlook, which I think will happen this Wednesday, investors should reassess their perspectives for the broader market and also for cyclical stocks like those found within the Industrial Select Sector SPDR (XLI).
While I realize I'm going to take a bashing for showing up on GE's news wire after the stock climbed 12% since my April 19 sell recommendation, I'm reiterating it today nonetheless. It is likely that long-time owners of the stock will take this opportunity to pick apart my original analysis, but I have reason to believe that I was not wrong but early. That global economic slowing that I have been speaking about since the end of March is getting hard to ignore, especially in manufacturing, and I expect the Federal Reserve will have to agree this Wednesday.
GE is especially sensitive to a downturn in the economy, as evidenced by its beta coefficient of 1.4 and its first quarter earnings results. The company itself offered tepid expectations in its conference call when it last reported results, and Europe has only gotten worse since based on the latest economic observations of the European Central Bank (ECB). Sure, the ECB is projecting a turnaround this year, but it's all based on foreign demand, including from the U.S. If the U.S. is problematic, as I suggest, well then we have a conundrum.
Analysts have not adjusted their earnings estimates for GE (on average) since the last report, when they were lowered for the June quarter to $0.36 from $0.40 60 days prior. GE shares are up 12.1% year-to-date and 17.6% over the past year nonetheless. It's not because of better earnings expectations, obviously, but rather the result of capital flows into equity funds, partly because of GE's dividend yield of 3.2% and partly on a recent sector shift toward more cyclical ideas.
Capital flows should slow though now, given recent concern about Fed tapering. A downshift in the Fed's economic outlook this week would probably serve to draw capital away from the cyclical ideas, including GE. Trading at 14.2X the consensus EPS estimate for 2013, with long-term growth seen at 10.9%, is worrisome despite the dividend yield if EPS estimates could see further reduction on a lowered economic outlook. So I suggest that GE is threatened by the Fed and its potentially seminal event this week.