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Like bargain stocks? Most investors do. And of course, the bigger the pullback, the better the potential bargain. Just because a blue chip name takes an oversized tumble in any given month, however, doesn’t necessarily mean that stock is worth stepping into. Sometimes a modest sell-off is a hint of what’s to come.
Take Caterpillar (NYSE: CAT) and chemical company Dow (NYSE: DOW), as examples, and for that matter, Honeywell International (NASDAQ: HON). All three are of high enough quality to be constituents of the Dow Jones Industrial Average (DJINDICES: ^DJI). But the underlying reason these three particular names were the Dow’s worst performers last month is still intact. That is, they all rallied exceedingly well from March 2020 lows, but a dose of economic reality is finally sinking in.
Underscoring this premise is another key takeaway for followers of the stock market.
Big winners turn into big losers
For perspective, Honeywell, Dow, and Caterpillar lost 5.0%, 7.5%, and 9.7% — respectively — in June, versus what was essentially a breakeven period for the Dow Jones Industrial Average.
Image source: Getty Images.
Astute investors will recognize the common thread. Although not direct competitors to one another, all three are industrial names tethered to the broad economy. Dow makes chemicals. Caterpillar makes mining and construction equipment. Honeywell makes … well, a little of everything. They’re not headline-grabbing companies, but they make products that experience firm demand in robust economic times. It’s not surprising to see them all slide lower in tandem, just as it would be expected to see them rally together.
And it’s this latter idea that’s making buying into these blue chip names on this dip a questionable idea now. As much ground as these three industrial names lost last month versus the broad market, these pullbacks are only a drop in the bucket.
Between the lows of the pandemic-prompted sell-off in March 2020 and their peaks in early June, shares of Honeywell, Dow, and Caterpillar were all up triple digits. Caterpillar led the way with a 166% romp, while Dow closely trailed with its 165% gain over the same period. Honeywell’s 121% rally for this 14-month stretch isn’t quite as impressive, but that gain is plenty impressive in comparison to the Dow Jones Industrial Average’s 87% advance.
Data by YCharts.
The problem with huge gains is, of course, outsized profit-taking at the first sign of trouble. Now that investors have legitimate reasons to wonder if the recovery thus far is on shakier ground than anyone realizes, the market’s previous highest flyers are the names being shed first. And there’s certainly plenty of room for more downside.
Never say never, but never ignore the odds or clear clues either
The risk to acting on such doubt is the possibility that it might be misplaced. Perhaps the domestic and global economies are just fine, and industrial companies will keep chugging along. Ditto for their stocks. The Federal Reserve says May’s industrial output and usage of the nation’s manufacturing capacity both improved from April’s levels with productivity itself reaching its highest levels since the pandemic took hold. Caterpillar was confident enough in its future to up its quarterly dividend 8% last month, sending a broader bullish message about its operating environment by doing so.
It’s still an awfully big bet, though, particularly in light of the fact that a handful of closely related industrial stocks all just exposed their vulnerability at the same time.
Bottom line? One pullback from one name is curious. When many stocks of the same ilk start to struggle after logging similarly incredible rallies, it’s a subtle sign that investors’ bigger-picture mindsets about an entire sector are changing. Ignore such clues at your own peril.
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James Brumley has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.
