Does the Dow Have Caterpillar Inc. (NYSE:CAT) to Thank?

Caterpillar (CAT) and the Dow I mentioned the need for infrastructure in this country a couple weeks ago. One of the companies that could potentially benefit from this would be ole' CAT tractor … Caterpillar Inc. CAT.

Caterpillar, the agriculture and construction machinery giant, maker of everything from pavers to excavators and even turbines for energy generation, continues on its breakout to the upside after eclipsing its last resistance point of $72.00. Though the stock was down slightly in Monday's trading, the long-term upside prospects still hold from a technical and fundamental standpoint. The stock was resilient in Monday's session as the broad market moved lower in late-session trading.

But maybe we need to look at this situation the other way around. The 30 stocks that comprise the Dow Jones Industrial Average have collectively been a barometer for many investors for quite some time. But the fact of the matter is that this index may be somewhat flawed.

Consider this:

If you were to remove CAT from the Dow, the index would only be up 2.5% year-to-date compared to its current gain of 3.7%.
The Dow Jones' stocks are weighted by stock price, not by market cap, sales, or book value. The index is actually a “scaled average,” which means that it's not actually the average of all the prices of the stocks in the index, rather the sum of all the prices divided by a dynamic divisor. This divisor adjusts for dividends and stock splits, so these occurrences do not skew the average.
The next-highest-priced components of the index – DuPont DD, Boeing BA, and McDonald's MCD, combined with CAT – have a significant influence on the value of the index itself, much more than the remaining 25 stocks.
So in reality, five stocks have significant control over a large portion of the index's movement.

The question is, does the tail wag the dog in this case? Furthermore, is a group of five stocks really an accurate barometer of the overall marketplace?

Many experts believe that CAT, with its growing stock price and strong performance, has been actually “controlling” the index to some extent. Mathematically speaking, this makes some sense.

Technicals

Looking at the weekly chart below, one can see there really was minimal resistance between $72 and its current trading level of about $80. Do watch for short-term pullbacks here, as the stock may have been a bit overbought in the last week. There is good technical support around the $72.00 level.

Weekly Chart of Caterpillar (CAT) shares

The all-time high in CAT of about $87.00 came at the height of the agriculture-frenzy of 2007 and the charts show minimal resistance to that point. But certainly one has to ask themselves: why, at this point when the economy is just starting to get some legs under it, are we seeing 2007 euphoria pricing in CAT?

Fundamentals

There are several reasons that analysts like CAT at its current level and even potentially higher. On Friday, Credit Suisse again lifted its target price on the stock to $95, citing healthy demand and lean inventories. Then there is the long-term inflation case and the Fed's renewed mentions of easing, which would be beneficial for commodity prices and a cheaper dollar.

In addition, farmers here in the U.S. are looking to get more for their crops and are investing in the latest and greatest machinery to do it with. A weaker dollar also means cheaper CAT machinery for the rest of the world, which is another benefit for the company.

So with commodities, global growth, a weaker dollar, and strong technicals, there does seem to be a least a basis for CAT to continue higher. Seeing as how CAT seems to have a heavy influence on the Dow, maybe we need to keep our eyes on this stock in particular for overall direction.

Photo Credit: Nick Chill

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