Trade of the Day: Caterpillar Inc. Has Jumped Too Far

CAT stock is stretched, so use caution

Shares of industrial company Caterpillar Inc. (NYSE:CAT) surged another 5% on Tuesday on the back of a promising earnings report and outlook, bringing its year-to-date rally to nearly 50%. While CAT stock still looks to be well-positioned through the longer-term lens, in the near to possibly intermediate term, the going is getting a little too giddy in my eye, which sets up a so-called “mean-reversion” trade.

Trade of the Day: Caterpillar Inc. Has Jumped Too Far

Industrial stocks as a group have seen notable strength of late, which as a result of the Tuesday’s rally in CAT stock as well as that of 3M Co (NYSE:MMM) further intensified.

To be clear, from a trend-following perspective, this bullish trend is a good thing. However, adding to fresh long positions in these stocks up here right now smells like an awfully low-probability trade.

CAT Stock Charts

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Moving averages legend: red – 200 week, blue – 100 week, yellow – 50 week

For some perspective, let’s take a glance at the big picture through the lens of the multiyear weekly chart of MMM stock. Here we see that until just a couple of months ago, CAT stock had been stuck in a lousy long-term sideways consolidation range that from peak to trough measured a correction about 50% deep.

The bounce back off the early 2016 low, however has been nothing short of miraculous. The past few weeks on the other hand have now taken this stock’s slope from steep to parabolic, and this rate of change is very likely not sustainable.

Furthermore, applying technical analysis 101 would argue that in order for Caterpillar stock to ultimately push well higher again, it would first need to do some sort of “re-test” of the breakout level (blue horizontal) around the $115-$120 area.

Click to Enlarge

Moving averages legend: blue – 8 day, yellow – 21 day

On the daily chart, we see that Tuesday’s up-gap and rally has now removed the stock significantly from its yellow 21-day simple moving average. At the same time, momentum as measured by the MACD oscillator at the bottom of the chart is at levels last seen in 2012.

Additionally, my proprietary Vertical X Pro indicator taking into consideration a multitude of factors flashed overbought by the end of the day on Tuesday.

As such, just about any way I slice it, CAT stock for the active investing and trading crowd here is beginning to set up as a mean-reversion (lower) candidate. Stock traders however would be wise to first see a down-day before legging into any short-side trades with a first profit target closer to $130.

Options traders, however, could look to sell out-of-the-money call spreads using options expiring in December or January.

Check out Anthony Mirhaydari’s Daily Market Outlook for Oct. 25.

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