After GE's Miss, Who’s Next?

I have argued for a while that US stocks are generally overvalued, as per my evaluation of General Electric (GE) (prior to its Quarterly Earnings report). The only part of GE that has apparently performed well is Infrastructure, Financials, Medical, and Industrial have all proved to be a disappointment.

The next two weeks will be crucial for Wall Street (many analysts will be working all weekend on re-evaluating bellwether stocks), but in my view the three most important stocks to watch are Citigroup, Merrill Lynch and Caterpillar.

Citigroup (C)

I expect write downs in the region of $15 Billion to be announced, and as a consequence I expect the stock to fall in the near future to around $12.

Merrill Lynch (MER)

I expect writedowns in the region of $10 Billion to be announced, and as a consequence I expect the stock to fall in the near future to around $22.

Caterpillar (CAT)

I expect pretty good results from Caterpillar. The slowdown will affect engine sales in the US, but will be more than offset by the exporting of construction machinery. Many US industrials will benefit from the weakened dollar in a similar manner to Caterpillar.

However the credit crunch will have an effect on the purchasing patterns of equipment leasing/buying. Therefore I am looking at a target price of around $70, in the next two months.

If Caterpillar's results are poor, it will be a very bad sign for the worldwide economy and a recession will be all but certain to occur.

Disclosure: None

Comments

[Lisa:]

"Therefore I am looking at a target price of around $70, in the next two months."

Meaning that even after good results, CAT's stock will fall? Or that the stock will do ok after earnings, but the overall market environment will pull it down over the next two months?

2008 Apr 13 03:29 PM

[Fighting Yoda:]

Results for financials are essentially managed - write downs, Level-3, etc. Financials still should be in the kitchen sink mode - so large write downs shouldn’t be surprising. How the market reacts is unknown - the markets have held up pretty well despite the impending gloom. Whether the C, MER etc crash to the indicated levels is anybody's guess (speculation)- however the trend is definitely downwards. I am short.
Infrastructure is another story - good or bad results from CAT and the like notwithstanding. It is all about sector rotation - investors have the money and have to at least some part of it somewhere. Infrastructure, commodities, energy etc is a very saleable story for now. Recommend buying on pullbacks.

2008 Apr 13 03:41 PM

[misdyrected:]

Another Nay-Sayer. Neg. Most likely a short buyer. These will survive. Go long. Buy low, stand strong.

2008 Apr 13 04:01 PM

[Anuj Varshney:]

I guess he is referring to the anonymous UK analyst, who has recently predicted a $10B writedown. He might be right in his predictions about the writedown, but I donot know what kind of sources he gets these information from.. i wouldn't trust him more than I do a psychic. But even for once if we assume writedowns to be $15 B, it is 13% of present market cap (112B), which might reduce the the stock price of 23.36 presently to around 20 (Notice the last earnings announcement when the writedowns were $18B, the stock trend starting with stock price of 26). Although it might seem that the 13% reduction might reduce growth potential of the firm, but its book value of $22 at the end of 2007 , which by the $15B might become $18.5(on the god-of-pessimistic assumption that Citi has no ability to generate returns on assets, indefinitely) i donot really know how he came up with this wierd figure of $12. Anuj Varshney
Baruch College
ibyleague.blogspot.com

2008 Apr 13 04:54 PM

[johnthebear:]

Great call on GE Chris. Now with this call and your discussion in an earlier post about the REITs and their likely drop in value, I have greater confidence in my short position on IYR. (using SRS) I was just reading in National Real Estate Investor that Capitalization Rates on New York real estate on property bought in 2006-2007 was only 3%-4%. (UK cap rates in this same time period were reported to be 4.56%) In my judgment, a cap rate of 6% would be the lowest reasonable rate justifiable for an all cash purchase.

The projection of revaluation of overvalued prime real estate over the next 6 quarters is bang on, in my book. GE will likely take a hit here as well. I agree with your call of $28-$30 range to buy back GE for a long term hold. Also, I think that we will all be shocked at how long it will take to recover from the housing and commercial property bust. I read that the AIA has reported the architects have almost no new business, which is a 9 month leading indicator for commercial construction. With the lack of bank financing at attractive interest rates this is certainly reasonable. You know, another factor no one seems to appreciate in the home lending business is that there are a huge number of mortgage companies have gone out of business and employment is down sharply. It will take a long time to rebuild the lending process so that each loan approval will be efficient. Just think, they may even require honest appraisals for both residential and commercial property again! The lenders have been forcing appraisers to make values high or they get no work. I am sure that will change. So, from the real estate side of the market, this will be a long painful process, perhaps many years to recover to the 2007 highs in real estate. As for the "real economy" some like to talk about, I am not sure there is a difference. After, it is built on the consumer and with the enormous loss of wealth in markets all over the world there just is no credible wealth to rebuild with except the sovereign wealth funds, and I would not count on that to redeem us.

2008 Apr 13 06:08 PM

[Ex15:26:]

I think the long-term trend is down as well, but would use caution.
I would be very careful making the statement that because they write these down, the stock goes down. What did we see the other day with the UBS disclosure? They wrote down $19 Billion and rallied! I am still short LEH, but I will tell you these rallies on bad news have tested my resolve and nerve. I am glad that I have a written trading plan for my positions that state why I'm in the trade and what is my threshold for loss, just so I don't lose my nerve.

2008 Apr 13 10:59 PM

[Chris Marshall:]

To John the Bear:

Thank you for your kind words. I was very interested in your comments regarding the AIA, I did not receive that in the UK.

Regarding fair value for properties, I believe that Texas, The Deep South and the Rust Belt are pretty close to fair value for residential properties.

Regarding CAP rates, look for at least 7%, in todays market. There are plenty of NNN leases from large Co's available on the open market at this level.

Regarding the financial stocks, the writedowns are only one part of the story, recapitalizing is required to boost their balance sheets and do not forget the GE effect, I think that market sentiment may turn bearish this week.

Regarding Caterpillar, I believe that they will have better figures than most, but as I feel that there will be a down trend, for market values, it just means that they will fall less than the rest.

Chris Marshall

2008 Apr 14 01:40 AM