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HomeMarketCaterpillar and 3 More Stocks to Buy for a New Market Rally

Caterpillar and 3 More Stocks to Buy for a New Market Rally

Caterpillar stock has taken off since late October.

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Bernd Lauter / AFP via Getty Images

The recent stock market rally could easily have more fuel in it. If it continues, so-called cyclical stocks are likely to be some of the top performers. 

The S&P 500 has gained just over 11% from its lowest close of the year in early October, mainly because the rate of inflation is falling. That has raised hope that that the Federal Reserve will soon begin to raise interest rates more slowly, tapping the brakes on the economy less firmly.

Higher rates are meant to help control prices by reducing demand for goods and services, but concern has built up that the Fed’s rapid rate increases to date will trigger a recession. That would hurt demand and corporate profits, potentially sending stocks lower.

Still, the current rally could easily continue for the next few months. The
S&P 500
recently broke out of a downtrend it had held since mid August, passing the key level of 3900 to trade near 4000 currently. That indicates buyers are more willing to step in at even higher prices, signifying increased confidence in the market outlook. 

“The S&P can continue to rally into the 4200-4300 range,” wrote 22V Research’s Dennis DeBusschere in a research note. 

If that happens, cyclical names—companies like
Caterpillar
(ticker: CAT) and
PPG Industries
—would likely keep outperforming. Those companies’ sales and earnings are more sensitive to changes in economic growth than, say, tech shares or consumer staples .

The idea is that if the Fed soon stops hiking interest rates, economic activity and earnings would hit bottom and then resume growing. Inflation would decline first, a short-term problem because slower price increases hurt the near-term sales and profits of cyclical companies. But the market would quickly look past that, focusing instead on the greater demand for goods and services a healthier economy would bring.

Cyclicals have already outperformed during the market’s upturn recently, but they remain relatively inexpensive. As a group, the cyclical stocks in the S&P 500 are trading at around 16 times the aggregate per-share earnings they are expected to bring in over the next 12 months, while noncyclicals are at roughly 21 times, according to 22V Research.

That leaves a gap of five times earnings, compared with the historical average of about two times, making cyclicals look relatively attractive. It is a sign they could be ready to move higher. 

Caterpillar stock has gained just under 50% from its low point for 2022, hit this fall. The stock has been a standout because its recent earnings report was stellar;

Per-share earnings at the maker of bulldozers and other heavy equipment came in about 25% higher than analysts had expected as rising prices helped sales and profit margins beat estimates. Even now, the stock isn’t wildly expensive, trading at 16 times forward EPS, still below its peak this year.

The stock’s technical signals indicate that gains remain a possibility. Caterpillar trades at about $238 a share, meaning its surge this fall has taken it above roughly $230, a so-called resistance area where sellers had come in earlier in the year to knock the price down. A move above roughly $245 could make bulls feel even more confident.  

Sherwin Williams
(SHW) is another example. It has risen about 16% from its low for the year, hit in October, taking it past key resistance at $220 to $234. The next hurdle to leap is resistance at around $260. Shares trades at 23 times EPS, a bit less than the peak for the year. 

PPG Industries (PPG), meanwhile, is up abut 19% from its October low to near $129. That leaves the stock in range of blowing past resistance at $130, but still well below the .next key level in the $140s. Shares trade at 18.5 times EPS, just under the high for the year. 

Lowe’s (LOW) is in the same category. It is up 21% from its low, breaking above the key $200 level. It needs to still move above the $210 area, though it it is trading at just 14.7 times earnings, below its high for the year. 

That all sounds rosy, but there are still key levels these stocks need to surpass in order for some investors to feel more comfortable buying them. Earnings multiples are heading closer to their highs for the year, so they’re certainly not as cheap as they were a few weeks ago. Meanwhile, the outlook for earnings is uncertain because it still isn’t clear how badly the rate increases the Fed has already rolled out will hurt demand.  

The bottom line is that these stocks might continue rising for the rest of the year, but at a slower pace than in the past few weeks. Next year might prove challenging for them. 

Write to Jacob Sonenshine at jacob.sonenshine@barrons.com

Credit: marketwatch.com

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