Caterpillar Leads the Dow Jones Today Despite Ominous Signs

Caterpillar (CAT 1.59%) is leading the Dow Jones Industrial Average (^DJI 0.40%) despite a continued fall in iron ore prices and some mixed reports on the U.S. economy. As of 1:10 p.m. EDT the Dow was up 15 points to 16,732. The S&P 500 (^GSPC 1.02%) was unchanged at 1,924.

Caterpillar is leading the Dow's meager rise today, up 1.2% to $103.45. It's unclear why the stock is up so much today. One possibility is that investors are reacting to the positive economic data out today.

Caterpillar has been dependent on its construction, energy, and transportation segments recently as its resources segment gets crushed. The Institute for Supply Management's purchasing managers index, as well as Markit's PMI, were little changed, showing that the U.S. economy is slowly growing. Construction spending increased by 0.2% in April, well below analysts' forecast of 0.8% growth. That growth is important, as Caterpillar is now dependent on its construction, energy, and transportation segments, which are nowhere near offsetting the declines in its resources business.

Two weeks ago Caterpillar released its three-month rolling sales report, which showed Caterpillar faces some real challenges.

Source: Caterpillar.

This month's sales reports will likely be worse as commodity prices, particularly iron ore, have continued to fall. The price of iron ore is seen as a barometer of economic activity in China, where the economy is dependent on infrastructure spending. As infrastructure spending drops, there is less demand for steel, of which iron ore is the main ingredient. The below chart is only updated to last month. Since then, prices have continued to fall, and as of yesterday prices for immediate delivery of iron ore to China hit $91.40 a tonne.

Source: Macrobusiness.com.au.

Iron ore prices are now down 30% so far this year to levels where over 25% of iron ore production is unprofitable.

Source: Credit Suisse.

Iron ore prices could sink low enough that mining becomes unprofitable for all but the lowest-cost producers. It is doubtful Caterpillar's construction, energy, and transportation segments will be able to make up for the shortfall entirely. At 18 times earnings, Caterpillar looks expensive with some real challenges ahead of it.