Stocks are up lately. Does anyone wonder why? Wall Street doesn’t seem to care, the media simply embellishes whichever view is most popular, and investors are just plain happy.
Quietly behind the scenes, however, two corporations have morphed into “alpha-companies.” Their success has propelled the entire market and contributed largely to the best September performance in decades.
The first alpha company benefits from the Dow Jones Industrial Average’s weighting mechanism. Unlike the S&P 500 and other broad market indexes, which weight stocks according to their market capitalization, the Dow is price-weighted.
With a stock price of $108, IBM (NYSE: IBM) is the biggest component of the Dow and accounts for 9.45% of the DJIA’s weight. Since IBM’s stock has been flat for the year, it hasn’t really done much for the average.
Caterpillar
Caterpillar (NYSE: CAT) is the fourth-biggest DJIA component with a weight of 5.58%. CAT’s stock has soared from $58 at the beginning of the year to as high as $80.
If it wasn’t for CAT’s proud performance, the DJIA would be up just 2.5% this year instead of 4.1%. Deduct the gains from the three next biggest contributors to the index — McDonald’s (NYSE: MCD), DuPont (NYSE: DD) and Boeing (NYSE: BA) — and the DJIA would be in red territory.
CAT has been the Dow’s frontrunner, it’s also become the VIP of the industrial sector (NYSE: XLI). Where did CAT’s profits come from? Certainly not from U.S. construction and home building (NYSE: XHB).
Over the past year or two, Caterpillar has laid off over 22,000 employees, more than a fifth of its work force. It’s fair to assume that this contributed to profit growth. A weak dollar also contributed to more sales and higher profits.
Much of CAT’s sales come from emerging countries (NYSE: EEM) such as China and Brazil and other global markets (NYSE: EFA). Also, the need for heavy machinery has come from increased mining activity, caused by higher (precious) metal prices.
A Double-Edged Sword
Caterpillar’s success story, albeit largely unnoticed, has been a huge boon for investors in the American market. But results tied to one “star performer” always bear risks. What happens if the star doesn’t perform? Who picks up the slack?
How much do currency fluctuations affect big, international players? As a point of reference, for every yen gained against the dollar, Toyota’s operation profit slips by about $400 million annually. What would happen to CAT if the dollar rallied?
“Are you kidding? The dollar won’t rally!” is what many think today. This is the same kind of sentiment that accompanied the November dollar bottom. Ten days before the dollar bottomed on Nov. 26, 2009, at a time when many were talking about a new reserve currency, the ETF Profit Strategy Newsletter noted: “The U.S. Dollar Index has been bouncing around 75 for over a month now and seems to either have found or be close to a bottom” and predicted a rally towards parity.
Following a huge dollar rally, the June 2010 ETF Profit Strategy Newsletter warned: “A temporary dollar top could occur any day” and mentioned that a Fibonacci 61.8% retracement could depress the greenback as low as 79.82. With the U.S. Dollar Index at 78.94, the rally towards parity might well be back on track.”
Applelicious
Apple (NASDAQ: AAPL) is the success story of the decade. Like phoenix from the ashes, Apple went from underdog to market leader in less than ten years. Apple stock rallied from $3 per share in 1997 to $294 in September 2010.
To put this monster move into perspective, over the same period of time Microsoft (NASDAQ: MSFT) has risen from $16 to $24.50, the NASDAQ from 1,600 to 2,350. The Technology Select Sector SPDR (NYSE: XLK) went from $32 per share in 1999 to $23 per share.
Due to a very odd weighting mechanism, Apple accounts for 19.94% of the NASDAQ’s performance. The next four biggest components — Qualcomm (NASDAQ: QCOM), Google (NASDAQ: GOOG), Microsoft and Oracle (NASDAQ: ORCL) — make up only a combined 16.05%.
Apple has an 11.36% weighing in XLK, followed by Microsoft, IBM, AT&T and Google with a combined weight of 28.48%. To no surprise, the Nasdaq (NASDAQ: QQQQ) has outperformed XLK by a ratio of 5:1 year-to-date — 8.06% compared to 1.72%.
Is Sky-High the Limit?
By June, Apple had sold 1.7 million new iPhones and three million new iPads. This is truly amazing. The question is, can this success be maintained and repeated again and again every quarter? If Apple or Caterpillar doesn’t deliver, who’d be there to pick up the slack?
The environment today is different than in the late 1990s. Back then investors didn’t require profits. A bright idea and a good business model were enough to get investors excited and stock prices soaring.
This isn’t the case anymore. Investors have become skittish and often bail at the first sign of weakness.
Will Apple and Caterpillar be enough to lead a nation out of the “Great Recession?”
It’s More Complicated
Their performance is a good start. But many CEO’s looking at AAPL and CAT stocks have become filled with envy. Quite possibly, the powerful duos strength could become the U.S. market’s Achilles heel. When AAPL and/or CAT sneeze, Wall Street catches a cold.
Navigating the markets in times of uncertainty is a daunting task. Rarely have there been more conflicting signals than right now. One way to manage your portfolio on a day-by-day or month-by-month basis is via trigger levels.
As the market moves through certain support or resistance levels, the probability of a continued move in that direction becomes significantly higher. Each bi-weekly Technical Forecast by the ETF Profit Strategy Newsletter provides such trigger levels, along with a technical picture that’s based purely on what the market has to say.
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