There is no doubt that Caterpillar Inc. (NYSE/CAT) has had a tremendous run since the fall. From a low of $67.54 in October to a recent high just over $116.00, the market sentiment has turned completely around. There are very few big firms that are capable of such a shift in market sentiment, which makes predicting markets that much more difficult.
Some research indicates to me that perhaps the stock is priced to perfection at current levels. Once market sentiment goes too far, either pessimistic or optimistic, this is when an investor can generate profits. Market sentiment always swings back and forth on a pendulum. The key is to wait patiently for the right time.
With quarterly earnings due out for Caterpillar on April 25, we can take a look at some possible scenarios and what the recent information may mean for the market overall. When predicting markets, try to gauge the underlying business model of the company and then see how that stacks up with the market sentiment. If there are signs that the business might be slowing down, but market sentiment is too positive, this is the time to be cautious and either take profits or hedge your position.
Chart courtesy of www.StockCharts.com
Research into Caterpillar’s statistics of dealer sales is showing a disturbing trend. Using a three-month rolling average on a year-over-year basis, the number of sales is decreasing, yet it’s still positive. Worldwide, last June, the sales rate was up 45% year-on-year, decreasing almost every month until February when it was at 21%. While that’s still great, stock prices are relative and represent market sentiment. If investors are anticipating growth like last year, this doesn’t appear to be happening. Europe has obviously slowed down, from June’s increase in sales of 53% down to 13% in February. Latin American sales dropped from an increase in June of 51% down to a miniscule six percent in February.
Does this mean we’re entering another recession? Not necessarily, as this is just one set of data and the numbers are still positive. However, if we look at this data set in 2008, the numbers kept going down in the previous year until it was fully negative. At that point, the shares traded below $25.00. Clearly, market sentiment went from too optimistic into a state of overly pessimistic.
Part of the recent upsurge was pent-up demand for sure, but the question is: what will future estimates be from the company in the next few quarters? Market sentiment is all about expectations. If we’ve already seen a huge build-up from clients, there is the distinct possibility that Caterpillar might guide downwards the market sentiment of investors. This is the key to predicting markets: being one step ahead of the crowd and the change in market sentiment. Note that there has been recent news of continued expansion of Caterpillar in other countries like China. China is another country that is slowing down.
Timing is everything when predicting markets and you must understand where the market sentiment is to gauge risks. From where the market is pricing Caterpillar, the risks are pretty high of a potential fall versus only a small gain left. Other companies in the space, such as Terex Corporation (NYSE/TEX), could be hit harder. Terex has a miniscule profit margin of 0.70%, versus 8.19% for Caterpillar.
When predicting markets that might get hit, take the underlying business clues and use them as inputs to figure out where the industry is headed and look for weaker players with a market sentiment that is too optimistic. This is your entry point to do some more research and see if you should hedge your position or even go short. Of course, your own risk parameters must be taken into account before any trade is made.