and broad market through all of the first quarter but has run into considerable headwinds in recent weeks. Chinese fiscal tightening policies and the European debt crisis have combined to knock this leadership issue down to earth after it struck an 18-month high on April 26.
While the stock is likely to head lower as we head into the summer months, the long-term chart may set up a dramatic buying opportunity that kicks into gear in the third or fourth quarter. This is great news for patient investors willing to wait until the stars line up perfectly, offering an entry price at a major low ahead of a long and fruitful uptrend.
Caterpillar entered a historic rally phase in the early 1990s, when the collapse of the military-industrial complex opened all sorts of international growth opportunities. The uptrend peaked in 1997 near $30, giving way to a six-year trading range that was finally broken to the upside in 2003, right at the end of the tech-driven bear market.
A second rally wave then unfolded in five major impulses, reaching the low $80s in 2006. The stock stalled at that price level and carved out a massive triple-top pattern that broke multiyear support near $60 in 2008. The subsequent decline was brutal, with price losing nearly two-thirds of its value in the next six months.
The vertical downtrend reached support at the top of the six-year trading range in February 2009, probed under that level for two months (red circle) and then lifted higher in a "V"-shaped recovery that returned to the broken top in November. It paused for five months and then remounted this major resistance level in April (red box).
The final surge through that resistance level ahead of the May downswing offers insight into Caterpillar price action from now into 2011. In a nutshell, the breakout opens the door to a test at the all-time high at $87, posted back in July 2007. But patience is required because there's plenty of time and space between those big monthly price bars.
The weekly chart shows a well-organized Elliott five-wave decline from the 2007 top into the 2009 bottom. The subsequent recovery has also unfolded in five waves, with the final surge lifting the stock above 2008 resistance and into $73, which also marks the 78.6% retracement of the prior downtrend.
This is a critical price zone that favors an intermediate correction that retraces up to 50% of a completed uptrend. However, the recent breakout has established new support near $60. This support was confirmed by the May 6 meltdown bar, which dropped price into that level, ahead of a quick bounce into the upper $60s.
Now comes the interesting part. Notice how the breakout extension (about 10 points) is nearly identical to the breakdown extension through range support back in early 2009. This upside/downside symmetry (red boxes), after opposite five-wave trends, suggests the stock will break through support and drop into a corrective phase that might reach as low as the upper $40s.
Let's see how these impulses may translate into buying opportunities. The daily chart shows support at $60, which will offer a great entry if the market magically recovers and allows this stock to head higher without a steep retracement. More likely, however, we're headed into a correction that drops Caterpillar another 10 to 15 points, as noted in my analysis of the weekly price structure.
A breakdown through support might correspond with a major downswing through the 200-day moving average, which is now rising into $60. I'd stand aside if that happens and allow the correction, which could take another two to four months, to run its course. Then, watch for a reversal at or near the 50% retracement level at $47.30.
Aggressive investors can scale in slowly near that level, while more defensive investors continue to stand aside. The actual buy signal comes when price pushes back above $60 (red "V") because it would signal a bullish "failure of a failure." In other words, I'm looking for the stock to break support and head lower, but eventually recover and lift back above the same level.
I believe the stock could nearly double in price and head into the 2007 high once the corrective phase has finally come to an end. In turn, that major upturn could set the stage for an historic breakout to an all-time high. That's great news, because Caterpillar nearly tripled in price the last time it worked through a similar price pattern, back in 2003.
At the time of publication, Farley had no positions in the stocks mentioned, although holdings can change at any time.
Alan Farley is a private trader and publisher of
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