What happened
Federal Reserve jitters continued to roil the stock market on Monday, as investors returned to trade on last week's news that nonfarm jobs growth in November was about 30% stronger than expected, and wage growth higher than anticipated as well.
That sounds like good news -- and if you work for a living, it is good news. But more people working and earning higher wages isn't necessarily great news for inflation, and that's what seems to be spooking investors in the industrial sector today. As of 12:15 p.m. ET, shares of industrial giants General Electric (GE +6.73%), Johnson Controls (JCI +4.39%), and Deere (DE +5.79%) are all down modestly -- 2.1%, 1.7%, and 1.8%, respectively.
NYSE: GE
Key Data Points
So what
The funny thing is, putting the economy to one side for a moment, the specific news on two of these industrial stocks today is actually good. As ratings watcher The Fly reports, both General Electric and Johnson Controls received positive price target increases from investment bank Deutsche Bank this morning.
Commenting that order growth seems "healthy" in the industrial sector, on top of large backlogs of existing orders already waiting to be filled, Deutsche Bank predicts that any recession in 2023 will hit mainly the consumer economy and leave the industrial sector mostly intact. Accordingly, the analyst added $5 to its price target for GE stock (now $94 a share) and $4 to its price target for Johnson Controls (now $74). And while Deutsche Bank didn't specifically mention Deere, its peer bank Citigroup did -- giving Deere's price target an $80 hike (now $505 a share) on Dec. 1.
Perhaps needless to say: Deutsche Bank thinks both General Electric and Johnson Controls are buys, and Citi says the same thing about Deere.
Now what
So why aren't these three stocks going up today? Why are they going down instead? The inflation issue. According to CNBC, stock investors of all stripes are selling today (the S&P 500 is down 1.2%) on worries that when the Federal Reserve meets to decide on interest rates next week, it might raise them another 75 basis points (instead of the expected 50 basis points), or signal that it wants to keep raising rates to a higher "terminal rate" -- or both.
A strong labor market, combined with new data today showing unexpected strength in the services market, gives the Fed extra arguments in favor of raising rates higher, more often, or both. And Fed Chairman Jerome Powell did seem to suggest last week that the Fed's eyeing a terminal rate -- the level at which it will stop raising interest rates -- of 5% or more. If it sticks to that opinion now that it has the data to support it, it implies that interest rates could rise two or more times from now before the Fed finally pauses to see what effect its hikes have on the economy.
What does this mean for General Electric, Johnson Controls, and Deere? In a nutshell, it means more money going to pay interest on debt, and less money going to profits for investors. With Johnson Controls carrying $10.2 billion in debt, General Electric $32.9 billion in debt, and Deere $51.9 billion, the sums are pretty significant, too.
At the same time, free cash flow (FCF) looks weak across all three of these industrial stocks. General Electric produced only about $2.5 billion in cash profits over the last 12 months (resulting in an enterprise value-to-free cash flow ratio of more than 45). Johnson Controls wasn't much better with $1.4 billion in FCF and an EV/FCF ratio of 40. And Deere looked worst of all: Flying in the face of its $7.1 billion reported profit for the past 12 months, Deere generated just $911 million in free cash flow, putting its EV/FCF well into the triple digits.
Honestly, while Wall Street thinks all three of these stocks are buys today, I wouldn't invest in any of them -- and I think investors are right to be selling.
