On January 25, the world's largest construction equipment manufacturer, Caterpillar Inc (NYSE:CAT) reported earnings of $2.16 per share, overshooting by nearly a fifth the $1.79 consensus EPS, and beating the estimated 11.98 by almost a cool billion at $12.9 billion revenue.
The company's share price activity epitomizes the theme that has been dominating the market for a long time: the rise and fall of President Donald Trump's reflation trade, which was reignited by a historic tax overhaul when he signed the 'Tax cuts and Jobs Act' into law on December 22.
While the 59th ranked company on the Fortune 500 list jumped nearly 3 percent on an intraday basis at that time, it closed with just a mediocre 0.6 percent advance. During the following session the price began to slide. At its worst, the stock shed more than a quarter of its value by early February and is currently almost 8.7 percent down.
What happened to the great earnings? What happened to the company's embodiment of the reflation trade? The answer may have much to do with the events of January 22nd, when President Donald Trump decided to impose as much as a 30 percent tariff on solar equipment imports.
What does solar equipment have to do with Caterpillar one might ask? The Trump decision was nothing new, rather an extension of the protectionist stance the president has taken since the very beginning of his campaign.
Despite the warning signs, investors chose to ignore the dark areas where a potential trade war might be hiding, and focus instead on the bright picture of his business agenda, a billion dollar infrastructure investment plan, a regulation rollback and the aforementioned tax cuts. The recent decision to impose tariffs on additional imports made it harder for investors to ignore than some theoretical "tough talk for his blue-collar voter base."
Usually it takes markets some time to catch up with the full implication of fundamental drivers. For example, while it's true that the market sold off on fears of higher interest rates after yields reached a 4-year high, it took a few days for the selloff to actually occur.
So what spooked CAT investors even on the day of its great earnings report?
Investors don't buy or short a stock for its current price, but for its perceived value and future price. Perhaps that's why despite a wonderful earnings report, the price failed to overcome the January 16th all time high of $173.24, missing it by 14 cents. Caterpillar relies heavily on exports. Last year alone, CAT exported over $24 billion worth of equipment, representing more than half of its $45 billion sales. This underlies the company's particular vulnerability to a trade war.
Some readers may be skeptical of this connection and find it unlikely that investors would be this smart. But here's another interesting fact. The president announced his intention to enforce a 25 percent tariff on steel and a 10 percent tariff on aluminum imports on March 1. Why then was the price of CAT shares already declining more than 5 percent since February 27, or half the fall until March 2, a full two trading sessions before the announcement? Perhaps 'informed money' knew something before the rest of us did.
Another insight regarding the reflation trade: it's likely over. The very theme that drove markets was that higher inflation would expand economic growth, which would include companies within the economy. However, when yields reached a 4-year high, at the first whiff of higher rates, investors sold off. After yields showed signs of easing (even when still above that 4-year high) investors convinced themselves that equity prices would still go higher.
However, after Fed Chair Powell paired growth with the potential for a greater than expected number of rate hikes and thus higher rates, investors ran for the hills, selling equities more aggressively. In other words, investors realized that the time to pay the [growth] pied piper (with interest) had arrived, and they refused to pay. The question is whether going forward investors will pay higher borrowing costs to keep acquiring equities.
Yesterday's drop wiped out nearly all of the previous day's value. Its red candle more than engulfed Friday's green candle, suggesting another, third decline. The first was after the solar equipment tariff and the second was on the metals tariff, even if it started before the actual announcement. Finally, yesterday's was on the very same metals tariff.
These swings have formed a Descending Triangle, and at this rate, prices would break out on the downside, completing the consolidation.
The steeper upper bound demonstrates that sellers' eagerness is growing, as they are willing to sell at ever lower prices, while the relatively flat lower bound suggests that demand is not meeting supply.
Note that yesterday's decline occurred after the intraday high reached a double resistance, in addition to that the triangle top, where supply has been kicking in: the 50dma (green) and more importantly the violated uptrend line since July 21, 2017, suggesting that the uptrend (at least at this steepness) is coming into question, putting the next uptrend line, since March 2017, at $132 per the current angle in play.
Note also that the 50 dma realigned with the triangle top, while the 100 dma (blue) guards the triangle bottom and the 200 dma (red) supports the uptrend line since March 2017. These demonstrate the crucial pressure points in the supply-demand balance.
The implied target of the triangle is $115. However, even if the $145 triangle bottom is breached, there is still the presumed demand waiting by the $135 uptrend line since March of last year, compounded by the 200 dma.
Conservative traders would wait for a formal reversal, when the February 5th, $142.85 trough is breached, forming a descending series of peaks and troughs, perhaps then followed by a 3 percent penetration of the uptrend line since March, 2017 depending on their risk aversion.
Moderate traders might be content with a second lower trough, or at least a downside breakout of the bearish triangle, acting as a reversal pattern, currently at $144.
Aggressive traders may short now, relying on the multiple resistances of yesterday's reversal, the broken uptrend line since July 21, the 50 dma and, finally, the upper-bound of a bearish pattern, the Descending Triangle.
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