How Big is CAT's Effect on Stocks and Economy?

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This CAT is bad news for the ‘Dogs of the Dow’ and has become the number one short target of a famed hedge fund investor.

Global construction equipment powerhouse Caterpillar (CAT) announced thoroughly disappointing second-quarter earnings on Wednesday.

Revenue dropped 15.8% to 14.63 billion and earnings slid 43% to $960 million. Perhaps more importantly, earnings and revenue guidance was lowered as well.

Caterpillar’s global dealers have been selling some of their inventory, but largely refrain from restocking CAT equipment due to lacking demand.

Related Article: Will $100+ Oil Be a Problem For Stocks And The Economy?

CAT already implemented factory shutdowns, rolling layoffs, and expense cutting programs and will continue to do so for the remainder of 2013.

A company like CAT, that operates in an economically sensitive sector and has tentacles spread out over the entire globe, provides an interesting gauge of the global economy.

Here’s a thumbnail sketch of why many are worried about CAT’s message.

Many of CAT’s customers are in the construction and mining sector. Take a look at ETFs like the Market Vectors Gold Miners ETF (GDX) and you know why mining companies aren’t in a position to chauffeur mined metals in the latest model dump truck.

Many metals, such as copper, iron or silver, are used in construction or technology. Slowing demand for metals cautions of a slowing economy. Dwindling demand for construction equipment has the same effect.

Just last week, famed short-seller Jim Chanos, founder of Kynikos Associates, picked CAT as his top choice to short for a number of reasons, such as deflating Chinese real estate bubble, slowing cycles and some accounting troubles

CAT And The Dow

Apparently there are plenty of reasons to be bearish on CAT, but how does this affect other stocks?

CAT accounts for 4.22% of the Dow Jones Industrials Average (^DJI) and Dow Diamonds ETF (DIA) and is the ninth biggest component.

As the chart below shows, there’s quite some directional harmony between CAT and the Dow Jones Industrial Average.

View photo

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In fact, from 2005 – 2011 CAT and the DOW carved out major highs and lows in pretty much the same week every time.

This changed in early 2012 when CAT started heading south while the Dow kept climbing higher. 

This phenomenon is not exclusive to CAT. We’ve seen a very similar lag with copper prices

(related article: Indicator Exposed: ‘Dr. Copper’ – More Quack Than Doctor)

and iron prices (related article: Iron Prices And Steel Producers ETF – Another Economic Indicator Sours).

What does this mean? There may be a very complicated and intricate explanation for this, but the most likely one is that the economy is weak, but the Fed and other central banks are strong.

Oh yes, and stocks might be in trouble … eventually.

Simon Maierhofer is the publisher of the Profit Radar Report.

Follow him on Twitter @ iSPYETF



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