The S&P materials sector is well positioned for a positive surprise as the global recovery gathers pace next year, even if developing economies remain laggards.
The downshift in Chinese economic growth, lackluster trends in commodity prices and the hangover from the previous investment boom have depressed material sector valuations and sales/earnings growth expectations. These forces have also changed the nature of the sector’s trading patterns.
For instance, prior to the financial crisis and during China’s economic boom, materials stocks traded in a highly anticipatory fashion: relative performance was inversely correlated with Treasury yields. The reflationary boost from lower yields (and a falling U.S. dollar) permitted investors to look ahead to faster growth, spurring a valuation expansion.
Now, the opposite is true. Relative performance is positively correlated with Treasury yields. This relationship is consistent with historical trends. Prior to 2000, relative sector performance and Treasury yields moved in tandem. The implication is that as global output growth pulls up factory utilization rates next year, the materials sector should surprise on the strong side.
Bottom Line: Our U.S. equity strategists recommend overweighing S&P Materials.