The Central Bank induced misallocation of investment capital has reached new heights. The about $14 trillion in negative yielding government bonds has caused a reversal in junk bonds starting in February even as default rates have increased. After 5 quarters of declining year over year profits for firms in the S&P 500, analysts are predicting a return to growth. This would imply the economy skipped the downturn in the business cycle even as it is as leveraged as it was at the peak of the previous two cycles.
Investors were piling into safety dividend stock like Con Ed and McCormick earlier in the summer as a replacement for bonds in an uncertain growth environment. Even as GDP has shown the first half growth to be 1%, investors don’t care. They have begun to rotate into more risky cyclical stocks. Deere is near its 52 week high even after reporting double digit sales declines.
The interesting thing about Caterpillar Inc. (NYSE:CAT) is it has benefited from the more towards dividend stocks and the move towards cyclicals. Finally, it has also benefited from the rally in oil E&P stocks as oil has rebounded to $47 per barrel.
The reason why I am reviewing the investor money flow is because it explains why Caterpillar is at its 52 week high. As I stated in the introduction, the reason for this entire situation being in place is because central banks forcing investors to take more risks to get adequate returns. Money managers can’t go into cash because of restrictions. It’s a widely held belief that stocks are the only game in town. This is a systemically risky situation because you have a stock market held by “weak hands” who don’t believe in the fundamentals of the businesses they hold.
Caterpillar is a great example of a stock that has to be held by weak hands. It is a company the central bankers have propped up with their dovish policies. It is a company trading at a 2016 P/E of 30.5 even as it has declining earnings with no sign of a rebound. As you can see from the chart of the most recent sales reported, Caterpillar has extended its year over year decline in retail sales to 44 months, reporting its second worst sales results of this period. The 3 month rolling average decline in sales went from -12% to -19%. After this poor result, the stock didn’t blink an eye and maintained its 52 week high level.