That's what the stocks of the big industrials are right here. And they are the reason why we are rallying, even as it may make no sense to so many people who do not understand rotations, short squeezes and under-ownership.
Let me set the stage.
This morning, Caterpillar (CAT) dramatically slashed its guidance for the first quarter. Wall Street was looking for Cat to earn 95 cents a share. But in a totally unnerving announcement, the company said it could only muster 65 to 70 cents for the quarter because of weak energy, transportation and resource orders.
It was an unmitigated disaster. The news immediately sent the stock, which had been red hot, down $2 in early-morning trading. It was such a powerful slap in the face that the entire S&P 500 futures market reversed from what looked to be a luck-of-the-Irish day to something resembling the potato famine.
But when the market opened, the stock of Caterpillar was down less than $1. And then, within a few minutes, it was actually up and then it started flying. It was one of the most startling reversals I can recall. Now, it is true that the news was grim. But Caterpillar held to its full year guidance. So maybe there was cause for optimism.
In reality, though, here's what's been happening behind the scenes. Ever since the bottom of this market in February when oil hit $26 and held, when fears about European bank failures died down and China's market stopped becoming a focus, we have seen rallies in the commodities, the very stuff you need Caterpillar earth movers to get out of the ground. Copper, aluminum, iron and, of course, oil and gas, which uses a tremendous amount of heavy equipment.
At the same time yesterday, the Federal Reserve decided that it wasn't going to raise rates in lockstep any more, as it promised in December. The four hikes in 2016 disappeared from the agenda as the Fed recognized the fragility of world growth.
This wasn't supposed to happen. The Fed was supposed to be tightening. When the Fed tightens, it makes sense to hold dollars because they will give you a better return, especially vs. the euro, which has been a real loser to own.
When the Fed switched directions it shocked those holding dollars hoping for a greater return on overnight money, which is exactly what you would get if the Fed had increased rates. So, it was dump-the-dollar-buy-the-euro time. Same thing with the yen, which suddenly got stronger vs. the dollar on this Fed switcheroo.
Hmmm. Caterpillar has a gigantic business overseas and it competes against companies that make goods and sell them in weaker currencies. They had been killing CAT's business both when it comes to translating weak currency earnings back into strong dollars, but also any machinery company that's based in Japan, as many of Caterpillar's competitors are, had been enjoying a huge edge against the Peoria company. Now, with the dollar peaking, something I talked about yesterday, the tables are turned. The new trend could be your friend.
But that's not all Caterpillar's got going for it. There's been a relentless increase in the price of copper, which requires earth movers to get at. It's the same with aluminum. Iron spiked and then went down a bit, but it's not staying down. And oil, where you need the biggest earth movers possible, especially in the Canadian tar sands projects, moved to $40 from $26.
So, you have to figure that even though Caterpillar annihilated its first-quarter forecast, this could mark the low in the cycle given the weaker dollar and the stronger commodity prices that could breed orders down the road.
But that's not enough to cause an actual rally on such horrendous news. No, that takes something else, something having to do with the business of money management. Many hedge fund managers are short Caterpillar because they figured that the quarter was terrible. They know the economy is weak. Didn't the Fed just tell us that yesterday? When the economy is weak the hedge fund textbook, so to speak, says short Caterpillar. The big institutions have been shying away or betting against this company for months and months.
But when you get the worst news possible, a gigantic number cut, and it doesn't go down, you have to ask yourself, if you are a short seller, what's going to drive this sucker down if not this terrible news? And if you are a hedge fund who sees this action and don't have enough cyclicals what's one of the most cyclical companies out there? Caterpillar.
So, institutions reach for it at the same time as the shorts try to cover.
You could see this coming. There have been signs, huge signs. On Monday after the close gigantic industrial Dover (DOV) preannounced some hideous numbers. Because of oil weakness, the company said in the evening note "We expect that our first quarter results will be well below our prior expectations entirely driven by our business with exposure to US oil & Gas markets." It noted that while oil has come back up, it was "cautious" when it comes to any recovery.
When I read it I said, there goes that run from $53 when the stock bottomed in January to $62 when the news came out. Sure enough the stock went to $61 the next day. And the next day after that? It went above where it preannounced a crummy quarter. Today it's at $65.73 and it might be able to take out its high.
Or how about ultra-cyclical Emerson (EMR), which has been such a dog for so long with endless number cuts stemming from weakness in almost all of its varied industrial businesses. Then, last night, Emerson issued order growth numbers that showed some green shoots, however meager. The company had been looking for orders down 5-6%. It changed its forecast to minus 4-6%. Sales instead of being down 10-9% were revised to down 10-8%. I told you, thin reed. But it said that it expects that trailing three-month orders would turn positive in April. Shazam! Emerson opens at $51 and then screams to $54 and change.
This news unleashed the floodgates to all stocks that look like Emerson. We saw Eaton (ETN) rally and Parker-Hannifin (PH), both with similar industrial mosaics. Illinois Tool Works (ITW) hit an all-time high. These are extraordinary moves.
Now not everything is just a teeny tiny better. Last night FedEx (FDX) reported $2.51 a share when people were looking for $2.34 and the commentary was extraordinarily bullish. I mean downright rip-snorting the-future-is-now bullish with incredible increases in Internet deliveries.
Now, you might ask where is this money coming from? Where is all that money needed to propel stocks like Freeport-McMoRan (FCX), which produces a trifecta of suddenly hot commodities, oil, gold and copper, or Pioneer Natural (PDX), an oil company that issued equity some 20% ago to fix its balance sheet?
The answer? Remember, we are in rolling bear market as well as in a rolling bull market territory. The banks, devoid of a rate hike, are coming down and coming down hard. The pharmaceuticals are being trashed, in part because of the ongoing saga of Valeant (VRX), the financially hobbled drug rollup with $30 billion in debt and, in part, because all of the major presidential candidates seem to despise these health care entities.
So, the money flows from the bear sectors to the bull sectors with a velocity that's shocking to all, especially those who thought that the economy worldwide was slowing and the Fed was going to raise rates anyway, making the recession-loving drug companies and the higher rate-seeking banks the favored groups.
Who knows how long it lasts. Is this Day 1, Day 2? Or is this it, a short-covering rally that has to run out of steam. I say watch the dollar. If it has topped out, as I think it has, this move's still got some gusto ahead of it.