There are two technical directives battling for the fortunes of Caterpillar (NYSE: CAT) right now. The first says to never try to catch a falling knife. The other, which traces back to 18th-century banker Baron Rothschild, says to buy when there's blood in the streets.
This blue-chip stock has likely seen the worst of its bear market and will pay us to hold it while we wait for better times that should be coming.
Shares of the heavy equipment maker certainly fell hard over the past six months from a perch above $111 to their current price just above $79. That nearly 30% decline qualifies as a full-fledged bear market.
And just when it looked as if some bottom fishers were coming in, the company released worse-than-expected fourth-quarter earnings and a weak outlook for the coming year. The stock plunged more than 7% on Jan. 27. While that sounds like bad news, it may actually be good news for the stock.
After a six-month decline, the huge single-day drop on gigantic volume looked very much like blood in the streets. Chart watchers call that a selling climax. In more poetic terms, the last believers finally bailed out, the decks were cleared and all hope was destroyed.
The theory is that everyone who wanted to sell has finally done so. Supply dried up taking away the real reason the stock could continue lower.
Just because the final panic likely occurred does not mean CAT will start to climb. It still needs demand, and with a plethora of "hold" ratings by Wall Street analysts, fear that the company's customers in mining and agriculture are also in trouble, and a strong U.S. dollar hurting overseas sales, there is no demand to be found.
But turning to the charts, this week's selling climax is rather clear with what looks to be an exhaustion gap -- an imbalance that could only be resolved by a jump lower instead of smooth trending.
Support was pegged in the $80-$82 zone from last year's trading range and several lows going back to 2011. In a climactic situation, when emotions and the "get me out at any price" feelings take over, an overshoot of a support zone is not unusual.
Sentiment remains bearish, although some analysts are now looking at fundamental reasons why the damage is already done. On Thursday, JPMorgan Chase (NYSE: JPM) said the potential for further declines is limited, upgrading shares to "neutral." But like JPM, the vast majority of opinions remain at "hold." One firm even downgraded CAT to a sell this week. A little late, I'd say.
I believe both mining and energy are going to make a comeback this year, and that would be good for Caterpillar. But I will respect the market and not expect CAT's rebound to happen right away. Still, I think the stock is on sale right now.
What makes it even more attractive is that it offers a nice 3.5% dividend yield, paying us while we wait. Compare that with the yield of the 10-year Treasury note at 1.8% with more downside risk than upside.
If I am right and CAT truly has washed out, I expect a bounce back to the $89 area, where there is resistance from the top of last year's trading range and an intermediate low formed in December. The 200-day average, currently in the $101 area, is starting to roll over to follow prices down. It should be in the $89 area in just a few months and makes for an enticing target.
Note that this is still just a bounce from oversold conditions. Even a rally to that average would not break the overall weak trend from last year, but only serve as a reversion to a mean, of sorts. A 10-point move from current levels would translate into a 12% gain. Add the 3.5% dividend yield and the total return prospects for a multi-month trade are attractive.
Plus, there's one more way you can accelerate your returns on this battered blue chip. Once you buy CAT, you have a little-known shareholder right that lets you "rent" out your shares. This brings in instant income without having to wait for quarterly dividend payments. And you can do it again next month, the month after that, and so on. To learn more about how this strategy works and how investors are using it to make $1,200 or more each month in additional income, click here.
Recommended Trade Setup:
-- Buy CAT at the market price
-- Set stop-loss at $76
-- Set initial price target at $89 for a potential 12% gain in four months, plus dividends
This article originally appeared on PofitableTrading.com: This Blue Chip's Sale Is Too Good to Pass Up After A Selling Climax