Caterpillar (CAT) - Get Report and Chevron (CVX) - Get Report are proud members of the Dow Jones Industrial Average, representing the best of American power and ingenuity. But the connection between the bulldozer maker and the oil refiner goes even deeper.
Earlier this week both companies broke support at $100, at exactly the same time, after trading in the triple digits for the last three months.
In addition, the two charts look remarkably similar, even though their businesses have little in common, except for sensitivity to economic growth cycles. The connection reveals a disturbing fact about the massive rally that ended in May. For the most part, the gains were manufactured by the notorious risk-on, risk-off trade, in which correlated baskets of equities were bought and sold in reaction to currency fluctuations and economic reports.
The venerable Dow had a prominent place in this notorious strategy, due to the international exposure of its 30 companies. That's probably why the narrow index has taken a shellacking in the last five weeks, dropping more than 6%. Sadly, selling pressure is likely to continue into the early summer, with the index dropping into a key test of March support near 11,500.
Amazingly, just six of the Dow 30 are trading above their 50-day moving averages after the five week decline. Former laggard
is the strongest member right now, after hitting a three-year high last week. A number of components are headed into key tests at their 200-day moving averages, which is a line in the sand between an intermediate correction and a major downtrend.
Although this is a bad time to step in and load up on these beaten-down issues, these stocks should recover first when the clouds finally pass. And it isn't too early to put together a shopping list of Dow favorites and to decide at what levels you expect them to offer a low-risk buying opportunity.
I am looking at four Dow recovery candidates. Just keep in mind that I'm more price sensitive than time sensitive with these highly-liquid issues, meaning I'm ready to sit on my hands for months if necessary, waiting for them to hit major support or to show signs they're attracting fresh institutional-buying interest.
Caterpillar posted an all-time high above $116 in May and entered an intermediate correction that pushed it below $100 earlier this week.
While it could bounce around this psychological level for another few weeks, I expect another leg down and a trip into the low $80s before the stock recovers and starts a sustained rally back to the high.
The weekly chart shows a strong support line in the lower $80s, at the highs posted in 2007 and 2008. That line is situated at the 38% retracement of the entire bull-market advance. The angle of the current correction suggests it will take another two to four months for the stock to reach that support level, so a buying opportunity could set up at the end of a long hot summer.
rallied to a two-year high at $76 in April 2010 and dropped into a trading range. It broke out in April 2011 and pushed up to the 62% retracement of the bear-market decline (red line). The uptrend then stalled and gave way to a pullback that's now accelerating to the downside. It looks like the selloff is headed for support at the 50-week moving average, currently near $70.
The stock failed to hold the breakout (upper blue line) but accumulation is holding up well, suggesting it will eventually find decent buying interest. But let's respect the downside for now and watch price action at the rising trend line (lower blue line), which is aligning with moving average support. A basing pattern at that level could emerge this summer, ahead of a fall recovery that might coincide with the release of the long-delayed 787 Dreamliner.
returned to its 2007 high at 82.50 (blue line) in February and entered a broad rising channel (red lines) that's still in place four months later. This volatile pattern points to a continuing test at multi-year resistance. While the stock has made little progress in recent weeks, it hasn't broken down like many other Dow components.
I don't recommend jumping in right here, but this is an interesting pattern because the company could assume the Dow leadership mantle in the weeks ahead and rally to an all-time high. But there isn't much to do until price returns to the May swing high (green line) and then breaks out. That event would issue a buy signal, ahead of a strong uptrend into triple digits.
I was negative and wrong for several months on
, watching from the sidelines while the fast-food giant rallied to an all-time high at $83.08. The stock is now pulling back with the broad market, but it's still outperforming other Dow components and should resume its leadership role after the downside washes out of the system.
The current decline has immediate exposure into the upper $70s, where the 50-day moving average and December 2010 high (blue line) should offer short-term support. But we might get an opportunity to own this stock in the mid-$70s, with major support at the 200-day moving average marking a final bottom, ahead of a late-year rally to new highs.
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
Hard Right Edge
, a comprehensive resource for trader education, technical analysis, and short-term trading techniques. He is also the author of
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, due out in April. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks.
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