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For generations of traders, Caterpillar (CAT) has been one of the most important U.S. economic bellwethers.
Caterpillar machines operate across construction sites, mines, energy projects, and major infrastructure developments around the globe.
When economic confidence is rising, businesses are more willing to invest in expensive machinery. And when conditions begin deteriorating, those major purchasing decisions are often postponed.
That means Caterpillar’s sales, order backlog, and dealer inventories can provide valuable insights into the strength of the global economy. Its stock price can also offer an early warning of changing expectations.
Yet CAT’s recent price action highlights an important distinction.
Even if a business is performing well and producing stellar results, that doesn’t automatically make it a good buy…
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Caterpillar has enjoyed a massive rally since April last year. Its shares have more than doubled since last September.
However, that rally wasn’t driven solely by traditional construction, mining, and infrastructure spending. Caterpillar has also emerged as a beneficiary of the artificial intelligence (AI) boom.
Building enormous data centers requires more than advanced semiconductor chips and computer hardware. Those facilities consume extraordinary amounts of electricity and need reliable power generation and backup systems.
That has created another important source of demand for Caterpillar’s engines, turbines, and generators. So a company traditionally associated with bulldozers and mining trucks has also become part of the AI infrastructure trade.
And Caterpillar’s most recent operating numbers have remained extremely impressive.
Second-quarter revenue increased 24% from a year earlier, while revenue from its construction business rose 35%. Caterpillar also booked $9.4 billion of orders, taking its backlog to $72.1 billion.
Yet the chart tells us something interesting. After surging through the $1,050 level around the end of June, Caterpillar began to roll over. Its stock price fell sharply throughout July, dropping below both its 10-day and 50-day moving averages (MAs).
You can see that price action below:
Caterpillar (CAT)
Source: eSignal
Caterpillar’s Q2 results in early August initially sent the stock sharply higher. Yet that move ran out of steam, with the 50-day MA (blue line) acting as resistance.
Note also how the 10-day MA (red line) has stayed below the 50-day MA since they crossed over in July. And the Relative Strength Index (RSI), a momentum indicator, has remained stuck in the lower half of its range. That shows that sellers have retained the upper hand.
Rather than marking the start of a new rally, that earnings spike became a lower high.
At first glance, Caterpillar’s recent weakness might appear to warn us that the broader economy is slowing.
But that doesn’t necessarily fit with Caterpillar’s recent results. Sales remain strong, its backlog is substantial, and data center construction has created another source of demand.
Instead, the chart may tell us that investors had already fully priced in all the good news.
Once expectations become too elevated, strong results may no longer be enough. A company must deliver numbers that substantially beat expectations.
That’s what makes Caterpillar’s failed earnings rally so significant.
Despite confirmation that the underlying business remains strong, buyers couldn’t push the stock back above its 50-day MA. The positive news generated only a temporary bounce before the downtrend resumed.
That’s a valuable lesson for every trader.
You might correctly identify that the economy remains healthy, infrastructure spending is increasing, and data center construction is creating new demand – that Caterpillar’s markets are growing.
But if everyone else in the market has already identified the same thing, there may not be enough buyers left to push the stock higher.
Before opening a position, consider what’s already priced in and whether the technical setup supports the trade. When a stock can’t hold a rally after positive news, that can tell you more than the headline numbers.
Caterpillar can remain an excellent company, and the economy can remain healthy. Yet against that backdrop, Caterpillar can still be the wrong trade at the wrong price.
Happy Trading,
Larry Benedict
Editor, Trading With Larry Benedict
Reading Trading With Larry Benedict will allow you to take a look into the mind of one of the market’s greatest traders. You’ll be able to recognize and take advantage of trends in the market in no time.
