Caterpillar Warning Highlights Trade War Risk

Dow component Caterpillar Inc. (CAT) missed fourth quarter profit expectations by a wide margin in Monday's pre-market while meeting revenue estimates and sharply reducing fiscal year 2019 guidance. A ferocious sell-the-news reaction dropped the stock more 5% in a few minutes, highlighting the company's dependence on China after a year of trade tensions, threats and tariffs have sharply reduced the Asian nation's economic growth rate.

This cyclical stock is highly dependent on healthy world economies, especially in China, and is likely to react strongly to trade negotiations that are scheduled to end in late February. This establishes a dangerous bilateral scenario, with external events dictating price development rather than internal fundamentals or technicals. As a result, the majority of market players should just stand aside and wait, ready to take advantage of deal or no deal after it's reported. 

CAT Long-Term Chart (1992 – 2019)

Long-term technical chart showing the performance of Caterpillar Inc. (CAT)

The stock ended a four-year downturn near a split-adjusted $5.00 in 1991 and turned sharply higher, entering a powerful trend advance underpinned by new growth opportunities following the fall of communism. It topped out above $30 in 1997, in reaction to the Asian Contagion, and failed two breakout attempts into the new millennium. Aggressive sellers took control when the internet bubble burst, dropping price to a four-year low in October 2000. 

A 2002 test at that level completed a double bottom reversal, ahead of a new uptrend that broke 1997 resistance in 2003. The stock outperformed broad benchmarks during the mid-decade bull market, with revenues growing rapidly in reaction to massive Chinese infrastructure investment. The rally ended in the upper $80s in 2007, giving way to a 2008 failed breakout attempt, followed by a steep decline during the economic collapse.

A six-year low in the lower $20s marked a historic buying opportunity, ahead of a V-shaped bounce that reached new highs in 2011. The rally topped out when Chinese growth eased that year, signaling a long period of underperformance that ended with the 2017 breakout. The subsequent uptrend posted an all-time high at $173.24 in January, 2018, ahead of a steep correction in reaction to worldwide trade tensions. The decline eased at breakout support and the 50-month exponential moving average (EMA) in October, raising the odds for a prolonged recovery wave. 

The stock has carved a long string of lower highs and lower lows in the past 12 months, and a buying spike above the November high at $136 is now needed to ease this bearish equation. The monthly stochastics oscillator flipped into a buy cycle in August 2018 and has held that orientation, even though the stock posted a 14-month low at $112 in October. Overall, this looks like a holding pattern while the U.S. and China try to negotiate a trade deal.

CAT Short-Term Chart (2016 – 2019)

Short-term technical chart showing the performance of Caterpillar Inc. (CAT)

A Fibonacci grid stretched across the uptrend that started in 2016 places the October and December lows at the .618 rally retracement level. Combined with breakout and moving average support, the stock may be entering a new uptrend that sets off buying signals on a rally above $136. However, the red trendline formed by lower highs could be equally tough to mount, marking additional resistance above $150.

The on-balance volume (OBV) accumulation-distribution indicator hit a new high in 2011 and failed to reach that peak when price posted an all-time high in 2018. Share buybacks in the past few years may be contributing to this bearish divergence. The indicator has dropped in sympathy with falling price in the last year but exhibits no sign of panic or a rush for the exits. This resiliency could also underpin higher prices in the coming months. 

The Bottom Line

Caterpillar is getting crushed after missing earnings expectations and lowering guidance but could hold 50-day EMA support just below $130 until trade negotiations wrap up next month.

Disclosure: The author held no positions in the aforementioned securities at the time of publication.

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