Following research I did on Caterpillar Inc. (NYSE/CAT) back in March, which culminated in the article, Caterpillar’s Cracks Indicate an Economic Slowdown. I said that, at that point in time, the stock was priced for perfection. If one had an investment strategy that incorporated technical analysis along with fundamental research, it was evident that the stock was due for a pullback. At the time of the article, the stock was trading at $109.00; with the current price being approximately $92.00, the stock dropped almost 16% in less than two months.
Looking at the investment strategy of Caterpillar, while the stock has sold off, there are still some warning signs. With China being a large engine of growth for the world economy, signs of a slowdown would impact one’s investment strategy. Recent reports that sales of Chinese bulldozers dropped 51% in March from a year earlier are certainly a red flag. Real estate construction continues to slow down and I think this could spread through the world economy.
Chart courtesy of www.StockCharts.com
In addition to more headwinds from a fundamental point of view, I also like to look at technical analysis when formulating my investment strategy. There are several interesting points of interest when looking at the technical analysis picture. I like to view the Fibonacci level in addition to the 50% retracement based on the opening and closing prices. In technical analysis, you should work with the indicators you are most proficient in. From the lows in October to the highs in February, the stock was overbought and due for a selloff, which we’ve just encountered. In technical analysis, if one indicator is used several times, this increases the importance of that level. Looking at the technical analysis of the selloff, once the stock price went below the 38.2% retracement level, the stock couldn’t gain additional buying support and the price fell to just shy of the 61.8% level. This range is extremely important in technical analysis, as evident by the indicated squares going back to last fall. Technical analysis tells us that a move beyond this range will most likely indicate the next big move, either a re-test of the lows or a re-test of the highs.
In technical analysis, following a large move, it is normal for a stock to pull back into this range and trade around its 50% retracement level, which Caterpillar is currently doing. Also note the oversold condition in the Relative Strength Index (RSI), noted with the circle. The indicators in technical analysis tell us that we might get a bounce back up, partly from new long-term investors and partly from short sellers covering their positions. This does not mean a new bull market, as we would need to see more technical analysis indicators confirm that. The overall trend is still down, but one must be aware of some buying support at current levels.
With the uncertainty in Europe and China, I think from a fundamental point of view that it might be difficult for this stock to exceed its highs in the short term. Most likely, we might get a small move back up within this trading range. For now, I think a lot of people looking at this chart from a technical analysis point of view will be trading the ranges and looking for a breakout to either side.