Caterpillar Says This Is High Water Mark For The Year–And Everybody Sells Everything

Caterpillar (CAT) crystalized the market’s fears in its conference call this morning.

After delivering really great results before the market opened–Caterpillar beat Wall Street earnings estimates by 72 cents a share on earnings of $2.82 a share and then raised its guidance for fiscal 2018 to earnings of $10.25 to $11.25, up from prior guidance of $8.25 to $9.25 a share–the shares moved up strongly, climbing by as much as 4.6%.

And then came the conference call. Caterpillar told Wall Street analysts that this quarter is likely to have marked the company’s peak for the year.

That sent the stock into reverse and the markets went with it. As of 3:45 p.m. New York time the Standard & Poor’s 500 is down 1.67% on the day; the Dow Jones Industrial Average is lower by 2.04%, and the NASDAQ Composite is off 2.01%.

Why did Caterpillar’s guidance set off such a big tumble in stocks today?

First, because the market is increasingly worried about interest rates. The yield on the 10-year Treasury pushed above 3.00% at its intraday peak, hitting 3.0014%. That’s the first time the yield on the 10-year Treasury has been above 3% since January 2014. The yield on the 10-year Treasury closed the day at 2.99%, 2 basis points higher on the day. Higher bond yields, stock investors worry, will send money from stocks to bonds and slow growth in the U.S. economy.

Second,  because the market is worried that profit margins will be contracting as the year goes along. This is the meaning of Caterpillar’s “high water mark” comment in its conference call. Investors and traders see higher commodity prices, higher interest rates, higher wages, and (maybe) higher tariffs as all cutting into corroborate profit margins in the rest of 2018. The fear is that the very heady earnings growth forecast for the rest of 2018 won’t turn into actual earnings growth. Right now this is one of those “the market scares itself” moments since higher commodity prices (except for oil) seem to be the result of temporary political moves by the United States and Russia, wage growth is mysteriously moderate, the Federal Reserve’s interest rate increases are advancing at a measured pace, and the “tariff war” is more future danger than current policy.

But the financial markets are aware that we are approaching the end of an economic cycle–this economic recovery won’t go on forever–and that we are witnessing very real pressure for gradually higher interest rates, and that the Tax Cuts and Jobs Act provided a one-time boost to earnings growth that won’t be repeated in 2019. In other words, the market is waiting for the shoe to drop and as is typical of these periods of anticipation it will sell off early and often with bounces in between until it gets the timing right. In my opinion, the timing is “righter” on an October time frame as Wall Street starts to issue more moderate forecasts for growth in 2019. But I no one ever gets these calls for a turn exactly right, except by chance, so we’re in for a lot of volatility as the market works the timing out

It doesn’t help the market today that the drop in the Standard & Poor 500 brings the 200-day moving average into play. The S&P 500, at 2634 just before the close today, has dropped decisively below the 50-day moving average at 2688. The 200-day moving average, the next big support level, is at 2607.89. That’s close enough to generate some nervousness.