One of my favorite ways to evaluate the stock market is by taking a macro, top-down approach. This means I research what's happening in the world's major economies and use this information to project how it may affect stocks in the near future. The key is to be able to discriminate between government action and true stock market movement.
As is well known, the euro zone seems to full of unending debt problems, things are said to be slowing in China and the United States just launched the third round of quantitative easing. However, stock markets are pushing higher around the world in seeming defiance of the macro-economic situation.
Two companies I consider to be barometers of the global economy are Caterpillar (NYSE: CAT) and Joy Global (NYSE: JOY), since both of these companies are vital for infrastructure build-out and economic growth.
Joy Global manufacturers mining equipment to extract critical raw materials needed for economic growth. Caterpillar is the world's largest maker of construction and mining equipment. Obviously, these two companies play a critical role in the development and maintenance of our industrialized society. But their performance paints a much clearer picture of what is really happening with the stock market than the daily ups and downs of the global economic news.
For starters, both of these companies are high-beta stocks. Beta is a measure of volatility against the broader market. The S&P 500 is the baseline, with a beta value of 1. Caterpillar's beta is 1.85 and Joy Global's beta is 2.13. So this means they should climb or fall at a more rapid pace than the market.
And since these two companies are at the "front-end" of so much economic activity, watching their moves may be a powerful tool to project what will be happening in the indexes and overall market.
Let's take a closer look at the performance of these global barometers to see what they can tell us about the market...
China isn't king
Many investors believe that Joy Global and Caterpillar are highly dependent on China as a growth engine. While China is important for their growth, it's not as critical as many believe. Despite the negative news, China continues to grow at break-neck speed. But its growth has not kept up with economists' forecasts. This is one of the reasons Joy Global and Caterpillar dropped more than 20% prior to bouncing back this year.
Although Joy Global has improved earnings by 13% and revenue by 22.2% year over year in the latest quarter, investors remained wary because of China's alleged slowdown. Caterpillar has seen year-over-year sales ramp up by an astounding 24% in North America and 27% in the Asian region. Despite the lackluster stock performance, these are strong signals of future improvement.
Caterpillar shares, although being knocked down earlier this year, are now up about 2%, mainly because of the recent jump in U.S. home building optimism. Joy Global has followed a similar highly bullish chart pattern with a price base being built in the $60 area.
Both these companies are forecasting that the rebound in the global economy is here to stay, thus stock markets will likely remain bullish for the rest of the year.
Risks to Consider: Although I think these two barometer stocks are well on their way to all-time highs, the future of the global economy remains uncertain. Use the same discretion and position sizing skills when trading these huge companies as you would with any other company. Regardless of their stature, trading these companies is just as risky as trading anything else.
Action to Take -- > Follow these two stocks if you want to know where the economy and stock market is headed. They're now also good buys.
Caterpillar has bounced from its mid-July lows and is now approaching the 200-day simple moving average. I would wait for confirmation of a break above the 200-day simple moving average, at $96 prior to entering a long trade in this stock. My target price is $110.
Joy Global has built an ascending triple bottom from its mid-July lows on the daily chart. This is a very bullish pattern. Although the price is still below the 200-day simple moving average at about $68, I would be a buyer on a breakout above $63. My target is $75.