Checking In on Caterpillar, Arista Networks, and Pinterest

In this podcast, Motley Fool senior analyst Bill Mann discusses:

• Global supply chain issues (understandably) affecting Caterpillar's (CAT -0.43%) results.
• How dividend-seeking investors should think about Caterpillar.
• Stellar results from Arista Networks (ANET -1.33%) and its longtime CEO Jayshree Ullal.
• Pinterest (PINS 0.21%) shares popping on user numbers and the backing of activist investor Elliott Management.

Motley Fool host Alison Southwick and Motley Fool personal finance expert Robert Brokamp talk about the indicators commonly associated with recessions and which ones they're watching.

To catch full episodes of all The Motley Fool's free podcasts, check out our podcast center. To get started investing, check out our quick-start guide to investing in stocks. A full transcript follows the video.

This video was recorded on August 2, 2022.

Chris Hill: We've got the latest in heavy equipment, cybersecurity, and social media. Motley Fool Money starts now. I'm Chris Hill, joined in studio by Motley Fool senior analyst, Bill Mann.

Bill Mann: How sweet does that sound?

Chris Hill: It certainly feels good to say.

Bill Mann: I mean, not the Bill Mann part, but the in studio part.

Chris Hill: It's pretty darn sweet. I got to tell you. Let's start with Caterpillar, shall we? Second quarter revenue lower than Wall Street was expecting due to supply chain issues and the company exiting Russia. This can't be a surprise. That was overwhelmingly my thought when I was reading through how Caterpillar did, and it's not terrible. The stock's down three percent about what you would expect for a company of their size and scope. But we're not really surprised by any of this, are we?

Bill Mann: We really shouldn't be. They had a miss. Their biggest miss came in the construction industry, which you could easily see why that would be the case. As you've said, there are supply chain issues, they've had a huge issue. One of Caterpillar's largest markets is China and things have ground to a stop in China in terms of housing construction, in terms of infrastructure construction. I guess to me, the surprise is that the consensus was as high as it was. This was a great quarter for Caterpillar, given that backdrop.

Chris Hill: Shares are outperforming the S&P 500 year to date, which is to say it's down but just not down as much as the overall market. I think of Caterpillar as being in the category of stocks that are big blue chip. They pay a dividend, they're not going to go anywhere. Am I missing something or is that how people should think about a company like Caterpillar? Like, hey, if you're looking to build out the dividend part of your portfolio, kick the tires on this one.

Bill Mann: Was that a joke?

Chris Hill: I didn't. [laughs] I really didn't mean it to be, I really didn't.

Bill Mann: Well done, though. Yes. Caterpillar is one of those companies that should behave about at the same level as global GDP growth, maybe a little bit ahead of it. It's a fine company. There are not that many competitors in most of Caterpillar's businesses at its size. But because it is so defined by how the economy is going, if the economy is not going well, for example, now their cost structures are really not going very well for them. As I said earlier, China's not going very well for them. They have supply chain issues. Yes. I mean, it is a great company to own. You are very unlikely to find yourself waking up one morning and Caterpillar has rugged you. But at the same time, it's not going to be a massive, massive grower.

Chris Hill: Thank you for using rug as a verb. Arista Networks, the cloud networking cybersecurity company posted second quarter profits and revenue that were higher than expected. They had upbeat guidance for the current quarter and yet shares are flat. Are we not entertained?

Bill Mann: We should be entertained. In fact, it's started this morning of up about 6.5 percent. By the time we actually end today, the trading day, it could be anywhere, was a great quarter for them. I mean, you could see why. Arista Networks is an absolutely necessary component in cloud computing and enterprise. They've grown very, very quickly, 49 percent revenue growth, which is if there was described as a little oasis of positivity in a market that doesn't show very much of it. They also talked about a supply chain environment that is troubling for them. Their quarter may have even been better, but their CEO, Jayshree Ullal, is one of the best in America. I mean, full stop. She is absolutely fantastic and managing their business at not getting too far ahead of their skis, and this is a company that is running on as many cylinders as you can be in the current environment.

Chris Hill: If you step back from Arista Networks, I don't want to say every company is going to be able to say this, but I feel like they're going to be a lot of companies this earnings season that we're going to have that to say about them like, hey, this was good and if they're doing this level of performance in this environment, the bull case is obviously, gosh, when things get better on a macro level, they're just going to tear the roof off of things.

Bill Mann: Have you ever seen one of those like word clouds?

Chris Hill: Yes.

Bill Mann: I think if you do a word cloud for earnings reports this time, the one that's going to be at the very center, gosh, it's two words, not one. One is supply chains. Supply chain is one that nearly every company will be able to credibly point to and say that this has been an impact on how they have done over the last quarter. Some of them will be using that as an excuse. But in a lot of cases it makes a ton of sense. Yes, for Arista to have come out and have been, as I said, this little oasis of positivity, I think that it's very credible to say that in a normal operating environment, whenever we got one of those, but in a normal operating environment, their results would have been even better.

Chris Hill: Jayshree Ullal, as Bill mentioned, the CEO of Arista Networks, she has been a guest of ours at Motley Fool investing conferences in the past. She is not going to be at this year's Fool Fest, which is our annual investing conference. It's a two-day event on August 29th and 30th, and there'll be breakout sessions featuring different investing strategies. We have a great lineup of speakers, including Trex CEO, Bryan Fairbanks, Motley Fool Co-founder, David Gardner, our friend Morgan Housel, Michael Mauboussin.

Bill Mann: Yes.

Chris Hill: Investor extraordinary Michael Mauboussin, who you're going to be interviewing on the main stage.

Bill Mann: I will and I can't wait. I'm glad that you actually got around to saying who was going to be there as opposed to who was because that's not good marketing. [laughs]

Chris Hill: I'm doing my best.

Bill Mann: I cannot wait.

Chris Hill: Yeah, it's going to be great. Fool Fest is free for Motley Fool members so. If you are not yet a member, that's easy to remedy. You can sign up for our Stock Advisor service and get a complimentary digital pass to the event. Just go to fool.com/foolfest. All one word for the details. I'll put the link in the show notes. That's fool.com/foolfest. The stock of the day is Pinterest. I don't even remember the last time I said that second-quarter results weren't great, guidance wasn't great, but shares are up more than 10 percent today after Pinterest user numbers showed some promise and activist investor Elliott Management confirmed that it is the company's biggest shareholder and has, "Conviction in the value creation opportunity that it sees," which I think is a fancy way of saying.

Bill Mann: It's cheap. [laughs]

Chris Hill: The stock is cheap and when these people get their monetization house in order, we think it can start ringing the cash register.

Bill Mann: Elliott Investment, they are no joke and they are specifically no joke within the social media segment. They've done great things at eBay. They were on their board, they've been on the board at Twitter. Maybe that's still a little bit of a work in progress, but they're not coming in. When you think of activist investors, you think of someone who's coming in and it's the Gordon Gekko, we're going to shake things up. They don't really have that opportunity to do so at Pinterest because the founder, Ben Silbermann, has the lion's share of the vote. He's got 37 percent of the total votes so they can't come in and push him around. Ben Silbermann decided to step away in June. Bill Ready is the new CEO, ex-[Alphabet's] Google guy. I would suspect that Elliott had a hand in having him come. It's going to be really interesting to see what they have to say as things progress at Pinterest. Pinterest is really the largest dataset that's out there for consumers that are not aligned with one of the big companies with [Meta's] Facebook, with Google, with Apple, so it's a great resource.

Chris Hill: It's going to be really interesting to see how this plays out because to this point, Bill Ready, who as you said, has been CEO for about an hour-and-a-half, nothing he has said and nothing that we've heard from Elliott Management points to pie in the sky aspirations both in terms of future guidance or in terms of levers that they can pull. They're talking about some pretty basic blocking and tackling ways to monetize the platform in a way that seems like it would be additive to the experience for people who use Pinterest and wouldn't drive them away. My hunch is that they are keenly observant of the language around Instagram and how people who have been on Instagram for a long time are talking about how the platform has changed and changed in a way that they don't really like. There is an opportunity here and you want to say, good luck. There's a way for you to do this without blowing it.

Bill Mann: Yeah, and so one of the things that they've pointed to was their international markets where on a per user basis they're only making a dime to about $0.15 per user. It should not be hard if you are at that level, and just to level set, Twitter makes a couple of dollars per user. Twitter again, is not even close to the best participant in this market. Pinterest has not done a great job in monetizing a huge amount of its members who show up and create their own material. They create their own content. They have a partnership with Shopify that they signed in 2020 that I think that they can lean on more, so you are not talking about an experience that should be that markedly different for its user base, which is always a risk. If you come in and you turn it, you go from being, this is something that is as helpful as possible to, it is as profitable as possible. Well, that's great, but you're going to be profiting off of a low or smaller user base by virtue of pushing people out. Pinterest, it's good news and bad news. They don't have to do much to be a much more profitable company.

Chris Hill: Let me ask you something about activist investors because you said, the image of Gordon Gekko coming in, we're going to shake things up. That's true in some cases. Is Elliott Management an activist investor that when you see they are involved in this company, the image, the reaction you have is positive, and if not, are there ones out there that you think, "Okay, this activist is getting involved all right, I'm going to pay a little bit more attention to this situation because these are serious people, these are not rabble-rousers?"

Bill Mann: It's a really good question and I would put Elliott at the top of the list along with Gotham Partners, with Bill Ackman, and Jana Partners, which are activists who aren't coming in looking for that quick hit. That's always the thought. Again, I brought up Gordon Gekko earlier, obviously in Wall Street, that's what he was trying to do to break up the company in profit anyway that he possibly could. These folks are long term investors now, they do come in with smiles but they are capable of going more hostile if they need to, but that's not their MO.

Chris Hill: As you said in the case of Pinterest, that's not going to work.

Bill Mann: Well, it could work. Yes.

Chris Hill: It's not going to work in the way that it would work with other companies where the founder is not there with the lion share votes.

Bill Mann: They can't vote anybody out by themselves. A proxy battle is not going to work out for them very well because at least 37 percent of the votes are already against them. But there are other levers that they could pull. You've seen it, you saw it with Uber where basically they embarrass Travis Kalanick out of the building. There are things that they could do, but I would not expect that to be the case with Elliott and Pinterest.

Chris Hill: Bill Mann, great talking to you as always, thanks for being here.

Bill Mann: Thanks, Chris.

Chris Hill: Are we in a recession right now? Are we headed toward one? Apparently, it's a little more debatable than we all thought. Alison Southwick and Robert Brokamp discuss the indicators commonly associated with recessions and which ones they're watching.

Alison Southwick: Here's something you're probably hearing in the news a lot lately. Key indicator falls fueling recession fears. Yes, the GDP decline for the second quarter in a row, and that is a big one. But what about the VIX, the Jolts, and someone named Sahm, who is making rules? As we've briefly explained before, recessions are officially declared by the National Bureau of Economic Research, which defines them as, "A significant decline in economic activity that is spread across the economy and that lasts more than a few months." While NBER is the final word, they tend to be more backwards looking like someone assessing a car accident, you know your car has been damaged, but you don't know the extent until you get an expert opinion. Today, we thought we'd talk about some of those numbers to watch that are perhaps a little bit more forward-looking, what they mean, and if they really are Harbingers of dark times ahead.

Robert Brokamp: We're going to take a look at four things that may or may not give you a hint about what the economy and the stock market is going to do. What's first up, Alison?

Alison Southwick: The VIX. What is it? Well, bro, the VIX is created by the Chicago Board Options Exchange or CBOE, and it's the Volatility Index or the VIX as it's efficiently and affectionately called. It's also known as the fear gauge, super not-for boating at all. It's a forward-looking benchmark for volatility over the coming 30 days. How? Well, they look at the prices of S&P 500 Index options with near-term expiration dates. Apparently, it's quite a complicated formula and you're welcome to google it yourself. Well, not always true, typically the VIX rises when stocks fall and declines when stocks rise. The higher the VIX, the more furiousness and uncertainty ahead. The highest the VIX has closed at has been in the low eighties, and that was back in March of 2020. The lowest it has closed is around nine and that was in November of 2017. Currently, the VIX is hanging out in the low twenties.

Robert Brokamp: It is right now at 21, which is the historical average. That's down from above 30 in mid-June. It came down because as you pointed out, it goes in the opposite direction of stocks and stocks went up. In fact, in July, the S&P 500 returned nine percent, and the NASDAQ returned 12 percent. Last July actually was the best month for stocks since 2020, so stocks went up, the VIX came down. You might ask, does any of this matter? I would say on most days, actually not really. I think the VIX is most interesting in the extreme. You probably have all heard that old Warren Buffett adage, "Be fearful when others are greedy and greedy when others are fearful." Readings in the low teens or even lower for the VIX, it could mean that investors have gotten greedy and maybe complacent. It generally happens after a few good years.

You pointed out the lowest rating was in 2017, another time when it got almost at low was 2007, and in both of those years, the following year, the market drops. We're not market timers at the Fool, so now saying that if the VIX is low, you should sell, but if the VIX gets real low, especially after a string of several good years, you might want to think about rebalancing your portfolio. Now, what about the other direction when the VIX has shot up? After all, there's another adage, "When the VIX is high, it's time to buy." According to Hartford Funds, there have been eight times when the VIX has been above 40 since 1990, and that was the year the VIX was launched.

There usually have been times when the market has either hit a blip or was in a full-blown bear market, so was that a good time to buy? While the S&P 500 posted a positive return a year later in six of those eight times. Basically a 75 percent success rate. That's actually about right in line with the historical average of stocks making money in three out of every four years since the 1920s. But I calculated the average one-year returns of the S&P 500 after the VIX hit 40, and I got 17 percent and that's well above the long-term average of 10 percent, though again, that did include a couple of down years. Three years after the VIX hit 40, the market was in positive territory every time. The jury is still out on the last time, which was during the pandemic panic of 2020, but we'll get the verdict on that in early 2023. There might be something to buying when the VIX is high, but during times when the VIX is just mosing around, not particularly high, not particularly low, like right now, I don't usually pay too much attention to it.

Alison Southwick: Let's move on to our next number to watch. The New York Times calls it Wall Street's most talked about recession indicator, and it's sounding, its loudest alarm in two decades. It's the yield curve. Yes, the yield curve compares the interest rates of various US government bonds, notably Three-month bills and two-year and 10-year treasury notes. Typically, investors expect to earn higher interest when their money is tied up longer. The 10-year pays more than the two-year and the two-year pay more than the bills that mature in three months. If you plot them on a chart with maturity time on the X-axis and the rate of return on the y-axis it makes a curve up to the right, just how we like our charts here at The Motley Fool.

But every now and then things get inverted and the interest rates for shorter-term US bonds are higher than the rates for longer-term bonds, and the curve bends the other way, and that way is down and we like grafts that go up. When the yield curve is inverted, it reflects the feelings of investors that the economy is going to tank and it's got some predictive power so you may be wondering, what is the yield curve up these days? But apparently the signal it is sending hasn't been this dire since late 2000, when the bubble in tech stocks have begun to burst and recession took hold. This is what I'm seeing in the headlines, Bro, is it really that dire?

Robert Brokamp: I would say this is actually one that I do pay attention to, so according to a reserve study published in 2018, the yield curve has inverted before every recession since 1955. That said, the timing is rather variable. The recessions have come within six months to as much as three years after the inversion, so it doesn't mean you have to panic immediately. According to Anu Gaggar of the Commonwealth Financial Network, the spread between the two year and 10 year notes has inverted 28 times since 1900 and 22 of these instances, a recession followed. There happens six false alarms over the 120 past years. But still, it's a pretty remarkable record, so where are we now? So the two year 10 year yield is inverted, the two year is yielding 2.9 percent, the 10 year is 2.6 percent. That 10 years come down pretty significantly since above 3.5 percent in June, so that's been a big drop. But the three-month and 10 year is not inverted in many people think that's the one you should pay most attention to, including Fed chair Jerome Powell. But the bottom line is, regardless of whether or not we enter a tactical recession, the yield curve is telling us to expect that the economy is going to be sluggish for awhile.

Alison Southwick: Next number to watch. The housing starts track how much residential housing was, started. It's a weird little phrase, but somehow it works. The census bureau releases the figures on the 12th business day of the month, they estimate housing starts from building permits issued by a sample of local permitting offices and then track those projects through completion and sale. Buying a new house is a big ticket item and then of course you have to fill it with stuff. If there are a lot of houses being built in response to demand, then that's a leading indicator of the health of the economy and future spending. It reflects the level of America's optimism and ability to even afford a house and all the things that go in it. How are we feeling America? Are we ready to go buy a house? New US homebuilding activity fell to a nine-month low in June. Not great, but with all the supply chain issues and rising interest rates, you're probably not too surprised to hear that.

Robert Brokamp: Because if we were to think about like all the parts of labour that go into building a house. There are all the materials and then there're all the workers, the plumbers, electricians, to turn it into a house and not to mention all of the sales team that gets together and sells the place. That's a lot of economic activity under one roof. A lot less activity when fewer walls and roofs get constructed and that's what's happening now, to new homes and also to existing homes but it's the decline in housing starts that can really weigh on the economy. Lance Lambert wrote a good article for Fortune.com in which he argues that this is what the Fed wants because it'll bring down inflation and here's one of the early paragraphs. "Historically speaking, the Federal Reserve's inflation-fighting playbook always starts with housing, it goes like this.

The Central Bank begins playing upward pressure on mortgage rates, not long afterwards, home sales sink and existing home inventory spikes then homebuilders begin to cut back. That causes demand for both commodities like lumber and steel and durable goods like windows or refrigerators to fall. Those economic contractions then quickly spread throughout the rest of the economy and in theory, helped to rein in runaway inflation." Frankly, so far it's working, sales are down inventory is up and an increasing number of people are cancelling their housing contracts. Housing starts or something to keep an eye on and right now they're not looking too good.

Alison Southwick: We talked about housing starts and then of course before that the yield curve and both of those seem to suggest that a recession is common around the mountain. But there's a reason why Harry Truman once said, "Give me a one-handed economist. All of my economists say 'on the one hand, but 'then on the other." These days the other hand is unemployment. Many experts argue that it's hard to say we're in or near a recession when unemployment is at 3.6 percent, the second lowest rate over the last 50 years. They're almost two openings for each person looking for a job which is historically very high. How will we know when things begin to change? You could look at the job openings and labour turnover survey, AKA the jolts put out every month by the Bureau of Labor Statistics. Job openings are indeed starting to fall as of the main numbers. But if you're looking for how we'll know if the job market is indicating we're in a recession, have you considered the Sahm rule developed by the former Federal Reserve and White House economist, Claudia Sahm. According to this indicator, when the three-month moving average of the national unemployment rate rises by 0.5 percent or more relative to its low during the previous 12 months, we're likely in a recession.

Robert Brokamp: The Sahm rules are relatively recent development. It was just announced to the world in 2019 and by the way, Sahm is spelt S-A-H-M in case you want to look it up. According to the original research paper, since 1970, there were no false alarms. Thus, it seems like a pretty good recession indicator from the job market. What is it saying today, while the current unemployment rate of 3.6 percent is the lowest we've seen over the past year. The Sahm rule would be triggered if the three-month average rose to 4.1 percent. Given how the job market looks, it seems like it would take several months to get to that point, but we'll keep an eye on it.

Alison Southwick: Now Bloomberg, they also do a monthly survey of economists, and they found that the probability of a downturn over the next 12 months stands at 47.5 percent and that's up from 30 percent odds in June. Bro, after we've finished talking about all these numbers in all the fields, the question is, does the fear of going into a recession, should that change how you invest and save today?

Robert Brokamp: It certainly makes sense to keep an eye on these things and if you are in or near retirement, once things start looking a little dicier, it might make sense to play it somewhat safer, maybe rebalance your portfolio, maybe have a little bit, but we're cash on the side. Of course, the market is already down, some of these indicators, like the flattening of the yield curve for giving a warning at the end of last year and if you paid attention, then that would have been a good time. If you're still working, the number one risk of a recession is job loss or maybe a pay cut. What you should be doing is really taking a look at your job and making sure you're demonstrating as much value as possible to your employers and your customers to ensure that you'll still be able to earn a paycheck regardless of what happens to the economy.

Chris Hill: As always, people on the program may have interest in the stocks they talk about and The Motley Fool may have formal recommendations for or against them, so don't buy or sell stocks based solely on what you hear. I'm Chris Hill, thanks for listening. We'll see you tomorrow.