Cyclical stocks have been one of the biggest surprises of earnings season, and CNBC’s Jim Cramer said Monday he has a theory to explain it.
The ” Mad Money” host laid out five reasons why these stocks have been resilient – and what it means for investors.
1. Difficulty interpreting results
The mood on Wall Street is currently the gloomiest it’s been since perhaps the Great Recession, Cramer said, pointing to the widespread belief that the U.S.-China trade war has weighed down the world economy, in addition to other uncertainty caused by geopolitics.
The negative outlook caused analysts to cut overall earnings estimates, with cyclicals taking a share of the shortfall, Cramer said.
“That makes it hard to interpret these quarterly results because the analysts have cut their estimates beforehand. Nobody was looking for anything good” from Caterpillar, Cramer said, using the heavy machinery manufacturer as an example.
So when Caterpillar missed on both third-quarter sales and earnings, it’s stock fell in pre-market trading yet eventually finished slightly up for the day as management told an encouraging story on a conference call.
“Thanks to those analysts who downgraded going into the quarter, the stock had already been softened up, which made it a lot easier for Caterpillar to bottom and then immediately bounce right back,” Cramer said.
2. Bad news immunity
Many cyclical stocks are really cheap to begin with, Cramer said, creating a built-in layer of resilience.
Take McDonald’s as a piece of contrarian evidence. While the fast-food titan also had its outlook downgraded preceding its earnings report, a poor showing led the stock to fall – and stay down. It remains down about 18 points, Cramer said.
“Why? Because McDonald’s lacks the secret sauce that protected the cyclicals: Mickey D’s stock is expensive, but the industrial stocks have finally gotten so cheap that they are basically immunized against bad news,” Cramer said.
The fact many cyclicals have committed to boosting dividends and share buybacks also helps their stocks hang in there, Cramer said.
3. Management matters
Management teams deserve responsibility for the “bizarre strength” in cyclicals, Cramer argued.
“Their management teams turned out to be far more savvy than anyone imagined,” the host said, referencing the work of PPG CEO Michael McGarry.
“I’m used to seeing these guys cut numbers in a downturn because they’re levered to everything from planes, to cars, to buildings,” Cramer said.
But McGarry was out ahead of it, Cramer said, rapidly pulling back on costs to minimize impacts of a shortfall.
That’s why PPG’s quarter wasn’t quite as poor as predicted, Cramer said.
“McGarry even called out the auto business as a source of strength,” he said. “In other words, these executives learned from the Great Recession and they’re not gonna let themselves get blindsided again.”
4. Not your father’s cyclicals
“The cyclicals that are working here have decided to change their stripes, to the point where they deserve higher valuations than they used to,” Cramer said.
Illinois Tool Works is a perfect example, Cramer said. The Glenview, Illinois-based manufacturer was projected to badly miss on earnings, due in part to a sluggish auto industry, according to Cramer.
But on its conference call, Cramer said he learned about the strength of Illinois Tool Works’ non-auto-related businesses, including science and patents, at which moment he “realized it’s a better company than people think.”
“They’re not just gonna sit there and take a beating.Illinois Tool Works had margin improvement in pretty much everything, their raw costs came down, the company actually saw some strength in Europe,” Cramer said.
“That’s why the stock caught fire. It gave up a little bit today, but it’s a comer.”
Railroad companies offer a similar story, Cramer said, with operators such as Union Pacific and CSX adopting a strategy called “precision railroading” after decades of decline.
“They manage their trains more efficiently, making them more punctual and more convenient. And efficiency breeds higher earnings per share,” Cramer said.
It helped both companies keep earnings from falling equally as fast as revenues did, Cramer said. shake off revenue declines to keep earnings from falling equally.
“No wonder both stocks quickly bottomed and came roaring back,” he said. “They’re both buys.”
5. Economy might be OK
Earlier, Cramer detailed how analysts’ gloomy outlook could be adding to the resilience.
Another possibility, Cramer said, is simply that the global economy may not be on the cusp of collapse.
“I mean it’s possible, just possible, that things could actually be getting a little better around the globe, at least for these companies,” Cramer said. “If you think the trade war has gotten as bad as it’s gonna get, if you think the Brexit situation could actually be resolved, then these cyclicals are the perfect place to be.”
“Normally these stocks get hammered in the wake of a shortfall, yet this quarter they’re more likely to rally,” Cramer said. “It’s absolutely bonkers.”
But these five reasons help explain the cyclicals’ surprising strength, he said, and “honestly, in every single case, I think they have more room to run.”
Disclosure: Cramer’s charitable trust owns shares of Caterpillar. Disclaimer
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