China's growing economic weakness has ended a Caterpillar Inc. (CAT) rally dead in its tracks, dropping the Dow component more than 15% in just two weeks. The stock is now trading below the 50- and 200-day exponential moving averages (EMAs) for the first time since Sept. 4 and could test the 2018 low at $129.43 in the coming sessions. This bearish turnaround could also signal the start of a contagion that spreads into other American companies dependent on Chinese economic power.

An October 2017 MarketWatch headline proclaimed that "Caterpillar's big bet on China may finally be paying off."  The stock surged nearly 40 points in the next three months, topping out in January 2018 after President Trump began an aggressive campaign to reform Chinese trade practices. That initiative has now escalated into a full-blown trade war, with U.S. tariffs taking a toll on the Chinese economy while dropping the Shanghai Composite Index to a four-year low.

The construction giant has rallied and sold off in sync with China's economic fortunes for nearly two decades, adding to concerns that Caterpillar stock will enter a bear market if tariffs rise to 25% on Jan. 1, as threatened. The president could also expand the tariff list into the 50% of exported goods not currently being targeted, with both scenarios having the power to undermine stock performance into the next decade.

CAT Long-Term Chart (1992 – 2018)

The stock rose six-fold between 1992 and 1997, stalling out in the low $30s and dropping into a massive inverse head and shoulders pattern that broke to the upside in the summer of 2003. The rally impulse ended in the low $80s in May 2006, giving way to a triple top pattern that broke support in 2008, yielding a vertical decline to a six-year low. It bounced strongly in March 2009, completing a round trip into the prior high in the fourth quarter of 2010.

A breakout stalled above $115 in May 2011, at the same time the Chinese economy was topping out after a furious growth spurt. That peak and a rapid decline into the mid-$60s defined trading boundaries that held intact until a October 2015 breakdown, signaling a capitulative selling phase that also affected the broad commodity complex. A major recovery wave remounted the broken trading range in March 2016, setting off buying signals ahead of an August 2017 breakout that posted new highs into January 2018.

CAT Short-Term Chart (2017 – 2018)

The stock then reversed and sold off in an intermediate correction that carved a broad bull flag pattern into the August 2018 low, while the subsequent bounce broke flag resistance about five weeks later, setting off fresh buying signals. That bullish impulse failed on Oct. 10, when the decline pierced new flag support, exposing the price to continued downside that could test the August low, which also marks the 2018 low.

The on-balance volume (OBV) accumulation-distribution indicator stalled at the 2014 high in January 2018 and entered a distributive phase that reached a nine-month low in August. Buying pressure into October exhibited modest participation, consistent with the first major bounce following an intermediate correction. Selling pressure has increased substantially in the past two weeks, dropping the indicator into a test of the mid-summer low. Traders should watch this level closely because a breakdown would raise the odds that the stock price will also break summer support.

The Bottom Line

Caterpillar stock has failed a September breakout and could test the 2018 low in coming weeks, held down by tariff-induced weakness in its biggest growth market.

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