Caterpillar Stock Could Test 2018 Lows

Dow component Caterpillar Inc. (CAT) reversed on Tuesday after failing to reach the high posted when April 24 earnings triggered an opening rally followed by a 17-point slide. In turn, this bearish price action could presage a decline to multi-month lows that also completes the last leg of a broad topping pattern, raising the odds for a breakdown that ends the equipment giant's long-term uptrend.

Caterpillar needs cordial relations with China to continue on the fast track, but trade tensions are taking their toll. Meanwhile, the Asian nation just reported weaker-than-expected investment, along with a slowdown in retail and home sales. More ominously, business surveys noted a sharp decline in export order growth that may reflect local company efforts to avoid getting caught with unsold goods during a trade war.

In 2017, Caterpillar saw the first sales growth in five years, with the slump driven by a Chinese construction slowdown and weak oil prices. Meanwhile, first quarter U.S. GDP dropped to 2.3%, increasing reliance on foreign sales to keep Caterpillar stock within striking distance of all-time highs. Tariffs could drive a lethal nail into the company's outlook, telling market players to keep a close eye on price action as we head into the summer months. (See also: Caterpillar Stock Whipsaws After Commentary Outweighs Guidance.)

CAT Long-Term Chart (2006 – 2018)

A multi-year uptrend stalled in the low $80s in 2006, giving way to a topping pattern that posted a nominal new high in 2007. It broke down in the second half of 2008, joining world markets in a massive selling spiral, driven by the economic collapse. The decline ended at a five-year low near $20 in the first quarter of 2009, generating a bounce that stalled about 15 points under the prior high in April 2010.

The stock completed the round trip in 2011 and broke out into the triple digits, stalling at $117, with that level marking an impenetrable barrier for more than six years. It sold off to a five-year low in January 2016, offering a low-risk buying opportunity ahead of a strong advance that broke multi-year resistance in the third quarter of 2017. The uptrend posted impressive gains into January 2018, lifting to an all-time high at $173.24.

[Learn about analyzing stock charts using support and resistance levels in Chapter 3 of the Technical Analysis course on the Investopedia Academy]

CAT Short-Term Chart (2017 – 2018)

A decline into February cut through the 50-day exponential moving average (EMA), marking the first violation since April 2017. Three rally attempts since that time have fizzled out as soon as the stock mounted that barrier, while broader price action has carved a sequence of lower highs. Sell-offs during this period have found support in a wide band between the upper $130s and low $140s, with highs and lows grinding out a potential descending triangle topping pattern. 

The stock dropped into the 200-day EMA in April, marking the first test of that level since June 2016. A three-week bounce reversed before reaching the late February swing high, maintaining the string of lower highs, while buyers emerged during a second test at the moving average in early May. The subsequent uptick reversed just above the 50-day EMA for the fourth time, right at the .786 Fibonacci retracement of the most recent downswing.

Prior bounces failed at or near this harmonic ratio, suggesting that the stock will now decline into the 200-day EMA for the third time. To paraphrase an old market saying, triple bottoms don't exist because third trips to lows usually trigger breakdowns. As a result, committed buyers need to step up here and carve a higher low in this bearish pattern, taking back control before the current decline reaches the breakdown level. (For more, see: Caterpillar: 6 Things You May Not Know.)

The Bottom Line

Caterpillar stock reversed with the broad market on Tuesday, driven lower by rising bond yields and continued trade tensions that could lower the need for industrial equipment in coming years. (For additional reading, check out: Trump's China Tariffs: What's at Stake for the US?)

<Disclosure: The author held no positions in aforementioned securities at the time of publication.>