Materials sector overview
Commodities have moved largely higher recently, with global monetary policies and a stronger global economy helping fuel gains. However, we still question the sustainability of gains and a tightening Fed gives us caution.
Market outlook for the materials sector
The materials sector has rebounded modestly from the dip it saw in the aftermath of the tariff announcements and didn’t react much to the recent imposition of tariffs on steel and aluminum, although steel firms did get a bit of a boost, as investors appear to be a bit less concerned than in the initial knee-jerk reaction. We believed at the time and wrote that the reaction was a bit overdone and that investors should continue to hold a market weighting in the group and continue to hold that view, and performance has indeed returned to a more modest level. We remain relatively positive on the sector and suggest investors refrain from knee-jerk responses to news headlines that may not be telling the whole story.
A positive economic picture in the U.S., as well as an improved European economy, are potential further tailwinds for the materials sector. Additionally, some indebted governments have scaled back their austerity plans and are focusing more closely on generating economic growth. This could provide a bit of fuel to the materials sector.
However, the possibility of a damaging trade war cannot be discounted and remains a risk to the materials sector. Additionally, there is uncertainty surrounding both U.S. monetary policy and global economic growth. European economic growth has improved as mentioned above, but remains modest and they are still dealing with some structural problems. Chinese economic growth has slowed compared to the past several years, though it has stabilized recently. Also, a continued strengthening of the U.S. dollar could hurt the sector, although that could be mitigated somewhat by better U.S. economic growth. For now, we're holding to our marketperform rating.
Factors that may affect the materials sector
Positive factors for the materials sector include:
- Increased demand: Developing countries continue to need more raw materials to support their infrastructure building.
- Accommodative monetary policy: Central banks in the developed world are now largely in easing mode, with the notable exception of the Federal Reserve, which should help to support economic activity and the materials sector.
- Reduction in austerity programs: Some global fiscal restraint measures seem to be easing, which could help to stimulate growth.
Negative factors for the materials sector include:
- Reduction in demand from China: Chinese demand for processed commodities might be slowing as technological advances and a build-out of production facilities allow the country to produce more of its own materials. China recently transitioned from being a net importer to a net exporter of steel.
- Larger inventories in China: Reports of large supplies could dampen hopes for a sharp rebound, as it could take time to work through those stockpiles.
- Increased labor costs: Wage costs are rising in the materials sector, as we've seen skilled-labor shortages in certain segments of the market.
- Trade concerns: If current trade disputes escalate into a full-blown trade war, the globally involved materials sector could be hurt.
Clients can see our top-rated stocks in the materials sector.
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