2 Stocks Controlling 20% Of The Market's Trend Give Hope For 2012

Includes: CAT, IBM, INTC
by: Brian Nichols

On Tuesday there were a number of market trends that we haven't seen in quite some time. The Dow Jones posted its first triple digit loss of the year, and its worst since November 23 2011. Both the S&P 500 and the Nasdaq posted their biggest loss of the year. And before today there had not been a sector to lose more than 2% in 2012; however on Tuesday half of the sectors finished with a loss greater than 2%. But what's amazing about the loss is that it was driven on very light news, yet all of the Dow Jones traded with a loss, except for Intel (NASDAQ:INTC). The price action on Tuesday has been much anticipated for quite some time, as investors have been awaiting a period of profit taking. And although there were several stocks to post substantial loss, there were two that really moved the market.

The Dow Jones is widely regarding as a gauge of market strength, despite having the smallest number of components. All but one of the Dow Jones' components traded with a loss on Tuesday, but two in particular controlled the trend of the index and may provide insight into what we can expect. Caterpillar (NYSE:CAT) and International Business Machines (NYSE:IBM) are the largest contributors to both gains and losses in the Dow Jones, and together accounted for more than 25% of its total loss.

IBM and CAT led the market lower on Tuesday, and much like the market, neither company had significant news to justify such large loss. IBM, which only lost 1.69%, may not seem to have had a substantial amount of loss, but for a company with a valuation of $230 billion, it's a substantial amount to heavily weigh on the market. However, CAT's loss leaves no room for discussion, as its 3.78% loss is large by any measure. These two stocks may trade in a completely different manner, and have little in common, but one similarity that both stocks share is that both usually lead the market either higher or lower.

Both CAT and IBM can give you an idea of the market's future direction. IBM trades with much less volatility, and has been one of the single largest contributors to the market's performance over the last year, with a gain of 21.5% and a solid uptrend. CAT is roughly 1/3 the size of IBM and is trading with a gain of only 3% for the year. CAT is one of the more volatile large cap stocks in the market that is not in the financial sector, trading with 88% more volatility than the market.

Aside from trading tendencies, there aren't very many similarities between the companies' fundamentals. IBM is a company of consistent growth that is slowly yet constantly improving its margins, revenue, and net income along with a very strong balance sheet and solid returns on its assets and equity. Caterpillar is far from consistent over the last five years, but is one of the fastest growing large companies in the market. CAT is also improving its margins, but rather than being a slow and consistent provider of growth, the company is growing revenue by nearly 35% and income by 60% year-over-year. However, CAT's balance sheet is questionable with a large amount of debt and less cash than what some investors would prefer.

It's safe to say that CAT and IBM have very few similarities; each company has different levels of growth, fundamentals, trading patterns, and a completely different business. Yet both companies share the similarity of controlling a large piece of the Dow Jones' trend on a daily basis. Both companies are weighed very similar to Apple (NASDAQ:AAPL) on the Nasdaq. If together CAT and IBM control 20% of the Dow Jones, then perhaps the best method of determining the Dow's future trend is to identify trends in both companies. The problem is that both stocks trade in a completely different manner. IBM doesn't really show a level of resistance since it just reached all-time highs on Monday. But CAT has had trouble around the $112 range for the last year. Therefore, with IBM being near its target price and CAT trading near its resistance it's possible that we could see flat trading until the resistance is broken, or possibly until further profit taking.

It's hard to identify a solid trend, but if recent history is any indication then IBM will continue to return gains year-over-year and CAT will be the fastest growing underperforming stock in the Dow Jones. Most analysts expect IBM to trade somewhat flat with an average price target of $200.29, however the stock has outperformed expectations each of the last three years. And most analysts expect 2012 to be a breakout year for CAT with an average price target of $131.61. Therefore, with CAT continuing to grow and IBM being one of the most consistently trading stocks in the market I think investors can count on performance of 20% of the Dow Jones, over the next year. In the end, profit taking is inevitable, but with these two great, yet different companies, weighing so heavily on an index that is so highly regarded, I feel confident in 2012's potential performance.

Disclosure: I am long CAT, AAPL.

Disclaimer: The information in this article is for informational purposes only. Consult your financial advisor before making any investment decisions. The data in this article was obtained from both Yahoo Finance and CNBC.com.