Caterpillar Squashed

Updated from 1:07 p.m. EDT

At record highs, the Dow Jones Industrial Average felt one of its pillars crumble on Friday as Caterpillar (CAT Quote) recorded a big earnings shortfall.

The industrial giant and Dow component, whose stock had been up 44% so far in 2007, posted a 21% drop in second-quarter profits and missed Wall Street's expectations. The company recorded sales strength from outside North America, but its bottom line was hit by higher costs and weakness in the U.S. residential construction market -- as well as the broader economy.

Shares recently were down $5.91, or 6.8%, to $81.07

While Caterpillar backed its earnings forecast for the full year, the company offered a sobering look at the U.S. economy. In particular, the company signaled that the dwindling possibility of an interest rate cut and a troubling housing-construction market may weigh on growth.

"U.S. residential construction looks even more distressed now than three months ago, the result of higher mortgage interest rates, falling new home prices, tighter lending standards and limited progress in reducing the stock of unsold new homes," Caterpillar said.

Also, it noted slowness in the commercial real estate sector, a sign that weakness from the housing market's slowdown is spreading.

"U.S. nonresidential contracting declined year to date even though some of the supporting factors remained positive -- office rents were up, business profits were good, lending to businesses increased and federal highway funding was up," said Caterpillar.