CATERPILLAR: Here's What The World Will Do This Year

Global economic bellwether Caterpillar just announced Q1 revenue and earnings that fell short of analysts expectations. Management also reduced its guidance for the year.

Because CAT is so closely tied to the economy, it has unparalleled insight into what's really going on.

Fortunately for us, CAT provides a pretty comprehensive and granular outlook for the global economy with its earnings announcements.

Here are a few key points:

• Global GDP will grow 2.5% this year.
• Central banks will lower interest rates further.
• Copper prices will average $3.25 per pound.
• The Federal Reserve will expand its balance sheet by at least 30 percent.
• The Eurozone will contract by 0.5% this year.
• Japan will grow by 1% thanks to the Bank of Japan's aggressive monetary policy.
• China will grow by over 8%.

Here's Caterpillar's full economic outlook:
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2013 Economic Outlook

Our expectation for world economic growth is about the same as the outlook included with our year-end 2012 financial results. We anticipate overall world economic growth of about 2.5 percent—a small improvement from 2.3 percent in 2012.

Purchasing manager indicators improved in the first quarter, and industrial production increased in the majority of countries. Both indicate that world economic growth is benefiting from monetary easing that started 19 months ago.

Central banks continued easing in the first quarter, and we expect the world economy will continue to improve in 2013.

Key points related to this outlook include:

• The modest recovery in the world economy since the financial crisis has failed to address high unemployment. The number of unemployed in the world is up about 17 percent since 2007, and central banks are gradually switching their policy focus from inflation to growth and unemployment. We believe this trend will continue throughout 2013.
• Most central banks reduced interest rates over the past 19 months, and average short-term interest rates in the world are near lows reached during the financial crisis. We expect further rate cuts in coming months.
• With interest rates at or near record lows in many countries, some central banks injected more funds (quantitative easing) into financial systems to promote lending and economic growth. With both Japan and the United States following aggressive quantitative easing policies, we expect other countries will eventually implement similar policies.
• Unprecedented central bank easing has raised concerns about potential inflation problems. Central banks that raised interest rates to address inflation concerns have returned to lower rates as most economies have not shown an ability to support higher interest rates or reduced liquidity.
• Inflation has shown few signs of becoming a problem, particularly in developed economies. After nearly five years of near record low interest rates, average inflation in the world is near a 40-year low. We believe that high unemployment and modest economic growth will keep inflation under control at least through this year.
• Demand for most metals and thermal coal increased last year, despite 2012 being the weakest year for economic growth in the current recovery and with industrial production in over half the world’s economies below 2008 peaks.
• Economic growth in 2013 should improve demand for most commodities, and we expect most prices will average slightly higher in 2013 than in 2012. We expect copper prices to average more than $3.25 per pound in 2013 and iron ore about $135 per ton. Iron ore is benefiting from an increase in steel production in China.
• U.S. natural gas prices averaged over 40 percent higher in the first quarter than a year earlier, reducing its attractiveness in generating electricity. As a result, we expect Central Appalachian coal prices should increase from $63 per ton in 2012 to $65 in 2013. We expect average Australian thermal coal prices in 2013 to be close to last year’s $96 per metric ton. World coal production will likely increase slightly, with growth occurring in Asia.
• Last year, Australian mining companies increased capital expenditures more than 50 percent while their profits declined 33 percent. This imbalance, which we believe occurred in other countries as well, has prompted mining companies to reduce capital spending. We expect this adjustment will continue throughout 2013.

Developed Countries:

• Developed economies recovered slowly from the financial crisis. Combined economic output in these countries is about even with the 2008 peak, representing nearly five years with no economic growth. Industrial production in the majority of these countries is below pre-recession peaks, and unemployment is up more than 40 percent.
• As a result, we expect interest rates in developed countries will remain at record lows throughout 2013, and that central banks will inject more liquidity into financial systems. Growth in developed countries should gradually accelerate throughout the year, improving to about 1.5 percent for the full year.
• We anticipate the U.S. Federal Reserve Board will maintain short-term interest rates near zero for the fifth consecutive year and expand its balance sheet at least another 30 percent. Consumer inflation averaged only 1.4 percent annually from 2008 to 2012 and is unlikely to develop into a problem this year. Overall, our expectations for U.S. economic growth are about the same as our previous outlook. We continue to expect growth of at least 2.5 percent in 2013.
• Housing starts in the United States averaged a 969 thousand-unit-annual rate in the first quarter of this year, the highest rate since 2008. We expect further improvement, with 2013 starts of about 1.1 million units.Housing affordability is near a record high, home prices are recovering, and the number of unsold new homes is near a 50-year low.
• Nonresidential construction in the United States improved in 2012, and we expect further increases this year.
• Positives include lower vacancy rates, higher property prices and some improvement in state and local government spending.
• Coal production in the United States declined 8 percent in the first quarter of 2013, but prices were within 5 percent of last year. Electric utilities generated more electricity and appeared to be allocating a higher fuel share to coal. We expect that some improvement in utilities coal burn and continued high coal exports should result in coal production down about 1 percent for the full-year 2013.
• We believe that economic policies in the Eurozone have not changed enough to address record high unemployment, a 20-year low in construction and over a year of declining output. We expect the Eurozone economy will decline close to 0.5 percent this year.
• We expect the rest of Europe will have modest growth, allowing marginal growth for all of Europe in 2013. Construction, however, is likely to decline.
• The Bank of Japan announced a target of a 45-percent increase in the monetary base by the end of this year, up from 20-percent growth in March. This aggressive program appears to be improving confidence. We expect about 1-percent growth in the Japanese economy. Construction orders, which are already increasing, should be up compared with last year.

Developing Countries:

• Developing countries cut interest rates in early 2013, and we expect further cuts this year will bring average rates close to lows reached during the financial crisis. We expect lower interest rates will improve economic growth to over 5 percent in 2013.
• Total credit advanced by the financial sector in China increased by a record amount in the first quarter, purchasing manager surveys improved, and infrastructure investment was up about 20 percent. Inflation has remained below target, which will likely allow the government to continue pro-growth policies throughout this year.
• As a result, we expect the Chinese economy will grow more than 8 percent this year, up from 7.8 percent last year. Construction activity is increasing, and we expect it will be up for the year. Imports of most key commodities increased in the early months of the year, and further growth is expected.
• Most other Asian countries also eased economic policies, and combined economic growth is expected to improve this year. Better growth should benefit construction.
• Inflation in most Latin American countries is within their central banks’ target ranges, which should allow central banks to keep interest rates low. We expect regional economic growth will improve to over 3.5 percent in 2013, benefiting from a recovery in Brazil and slightly higher commodity prices. Growth in construction has outpaced that in the overall Latin American economy in each year of the current recovery, a trend that we expect will continue in 2013.
• We expect economic growth in both Africa/Middle East and CIS will be over 3.5 percent in 2013, close to growth rates achieved in 2012. Most countries maintained policy stances close to those adopted in the financial crisis, and we do not expect any major policy changes during the rest of this year

Risks

• We believe that most countries tightened economic policies too early in the recovery from the financial crisis. As a result, world economic growth slowed in 2011 and again in 2012, resulting in the worst recovery in decades. Most countries have since reversed some of this tightening, but economies have been slower to respond than in 2009. Our concern is that central banks will again tighten policies prematurely as better economic growth emerges, particularly as some face criticism about the measures taken to deal with the slow economic growth.
• Eurozone leaders have shown almost no inclination to adopt more pro-growth economic policies. Without policy changes, we believe the current downturn, already five quarters long, may last throughout 2013.