GE, Caterpillar Stock Up for Economic Growth

Rising inventories at GE, Caterpillar and 3M suggest the U.S. economy is growing.
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BOSTON (TheStreet) - Caterpillar (CAT) - Get Report, General Electric (GE) - Get Report and 3M (MMM) - Get Report reported first-quarter earnings that beat analysts' expectations, priming the markets for optimism. Economic growth could push investors into a buying frenzy as they look for reasons to push hard into stocks, despite concerns about Greece's debt crisis and Goldman Sachs' (GS) - Get Report fraud allegations.

The Commerce Department said gross domestic product

grew 3.2%

during the first quarter. GDP is thought to be the ultimate gauge for the economy. However, regardless of the first-quarter GDP growth rate, there are other reasons to be positive about the economy's prospects.

GDP is a trailing indicator. The data are a month old and the factors that affected that performance may already be substantially different, making the current quarter's performance much different, for better or worse.

GDP estimates might be revised twice before they're final, and then they're still open to more revisions. While it's frustrating to have GDP data changing constantly, it's necessary to give an accurate reading on the economy.

Beyond this traditional thermometer of economic heat, investors should look at alternate indicators when forming opinions about the economy. The following three indicators are timelier, more accurate and forward-looking.

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Increasing Inventories Versus Sales

When companies are more confident about the future, they build inventory levels to meet expected increases in demand. If the company is worried about demand, it will likely cut production and maintain a tight inventory to keep costs down and cash free, rather than tied up in products.

During the fourth quarter of 2008, the inventory-to-sales ratios for companies like Caterpillar, GE and 3M climbed, not because of increasing inventory levels, but due to declining sales. In the first half of 2009, those ratios fell as inventories were cut. During the first quarter, those companies added inventory to meet increasing demand. 3M's inventory-to-sales ratio increased 2.3%, Caterpillar's rose 5.4% and GE's jumped a massive 12%.

"Economic conditions are definitely improving, particularly in the world's developing economies," Caterpillar Chairman James Owens said in the company's first-quarter earnings statement. "Industry activity and orders are significantly higher than last year and are at record levels in some areas. As a result, we are hard at work ramping up production to meet increasing demand from customers."

That statement must come as a relief to Caterpillar's employees who suffered through layoffs during the depths of the recession.

Companies are making stuff again because they think people and businesses will start buying stuff again. That translates into economic growth and stock market gains.

The Steep Yield Curve

The yield curve reflects the yields of various Treasuries, and show many things about the market's perception of growth, risk and inflation. During the time leading up to a recession, the yield curve often inverts, meaning that issues with long durations yield less than those with short durations because investors push to buy longer-term bonds for stability in anticipation of economic slowdown, which presses rates down.

The yield curve inverted in 2007. Investors that took this as a sign that economic hardship was coming could have moved out of equities at their highs in 2007 and avoid much of the pain that 2008 brought.

The opposite of an inverted yield curve is a steep yield curve. In this situation, long-term rates tower over short ones as investors demand a high return on longer-term bonds to compensate for tying up their capital when more attractive investment opportunities abound.

The current yield curve is quite steep, suggesting that investors see a lot of growth potential in the markets. The steepness has become less pronounced in recent weeks as the health of Greece and other countries weighs on investors, but the overall shape suggests that growth is expected.

Sometimes the yield curve can steepen when investors brace for inflation, but based on the spread between the inflation-indexed securities and standard Treasuries, it doesn't seem like that is the case. Investors should take this as a sign that growth is here to stay. Otherwise the yield curve would be flatter.

Consumer Confidence

Consumers are far more intuitive than you may imagine. Prior to the stock market crash in 2008, the Conference Board's gauges of consumer confidence and expectations fell off a cliff. Those predictions were proved right when the U.S. sank into a vicious recession and hundreds of thousands of jobs were lost along with many investors' retirement savings.

The Conference Board's readings have been improving, and while they may not be back to pre-recession levels, they are remarkably better than their lows last year. Confidence is at 57.9, its highest level since August 2008. Expectations are at 77.4, the best since October 2007, before the recession officially began.

Demand in the U.S. reflects spending by consumers and businesses. The inventory increases in the big industrial companies appears to suggest that businesses are coming back, and these figures point to a resurgence for the American consumer.

-- Reported by David MacDougall in Boston.

Prior to joining TheStreet Ratings, David MacDougall was an analyst at Cambridge Associates, an investment consulting firm, where he worked with private equity and venture capital funds. He graduated cum laude from Northeastern University with a bachelor's degree in finance and is a Level III CFA candidate.