From the desk of Steve Strazza @Sstrazza
As always, thanks to everyone who participated in last week’s mystery chart.
Responses were mixed but skewed in the bearish direction.
The point of our exercise was to question whether buyers would have the power to push prices back above our risk level… or if sellers would follow-through and validate the pattern breakdown.
If the former was to be true, we’d have a “bull-hook” formation on our hands. Some might call it a “bear-trap”. Either way, it’s bullish.
But that’s not what has happened at all. Since our mystery post, sellers have taken control as prices continued to collapse lower.
We’re now looking at a decisive violation of our risk level. Let’s dive in to see what’s really going on and discuss why this chart is so important!
The chart was a daily candlestick view of Caterpillar Inc $CAT with about five years of price history. Here’s what it looks like today:
CAT broke out of a multi-year base late last year and followed through with a swift rally to our primary objective ~226 at the 161.8% Fibonacci extension. During the 3-4 months since, we’ve seen price consolidate above our level as momentum has waned to the downside.
That changed a few weeks ago, as CAT collapsed, completing its short-term topping formation and confirming its bearish momentum divergence.
Making matters worse for CAT is the fact that this price action was confirmed by the lowest momentum reading (measured by the daily RSI-14) since last year’s COVID-crash.
The bias is now lower toward those former 2018 highs around $175. For now, we want to fade any strength back toward 226.
Let’s take a more tactical view of the chart:
Earlier this month, the stock violated support at a 15-month uptrend line drawn off last year’s lows. This suggests a pause or slowdown to the current uptrend and is typically one of the first characteristics we see when an asset is undergoing a change in trend.
Now that we know the directional bias is no longer UP, the only question that remains is simple: Are we transitioning to a sideways/trendless environment, or was that it… and now we’re headed down? We can only wait and see…
In the meantime, it’s worth noting that the CAT chart shares a striking resemblance to that of Copper and Lumber futures, which also recently violated key trendlines to the downside.
This is nothing out of the ordinary. In fact, the strong historical relationship between Caterpillar and risk assets is exactly why we wanted to use it as the mystery chart.
Caterpillar is a bellwether. It’s an index in and of itself. It represents investors’ expectations for global economic growth and is highly correlated with cyclical assets and commodities around the world. Not only is Caterpillar a great barometer for risk appetite for US Equity Markets, but for risk assets across the board.
To illustrate this point, check out how the chart of Caterpillar looks almost identical to Copper:
Let’s put this recent price action within the context of other risk barometers such as the Aussie/Yen (AUD/JPY), Emerging Markets, and Lumber…
The recent weakness from CAT is confirming what we have been seeing and saying about these other charts. Put simply, risk assets are resolving lower and suggesting an increasingly risk-off environment.
This chart of Caterpillar reaffirms our thesis and current position that we are likely to remain in a messy market environment for the foreseeable future.
Thanks for reading and please let us know if you have any questions!