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July 27, 2004 at 08:00 PM
July 27, 2004 — Materials sector funds can outperform their benchmark during periods of strong growth such as we’re now seeing in the U.S., offering investors a way to gain from the rebounding economy. However, good economic growth does not boost all materials funds, therefore selectivity is beneficial.
While recent economic reports such as June’s employment and retail sales figures were disappointing, the U.S. economy is still growing solidly, with GDP expected to climb more than 4% this year. As a result, the materials sector should benefit. This sector includes companies which produce items such as chemicals, steel, aluminum, paper and packaging products. As economic activity picks up, demand for these products increases.
Materials companies could also benefit from continued strong demand from China. While the government there is trying to moderate its red-hot economy (GDP growth recently “slowed” to 9.6% in the second quarter), demand for materials remains robust. According to Business Week, China uses 25% of the world’s supply of aluminum and 27% of all steel products.
However, the rising tide doesn’t always lift all boats. Some materials suppliers are better positioned than others, while others have reached valuations which already reflect the brighter economic outlook. This explains why S&P’s equity research department currently has a market weight, or neutral, recommendation on the sector as a whole. Opportunities exist, but selectivity is needed. This places even more importance on the choice of a good fund manager for this sector.
In order to see how materials sector funds performed under economic scenarios similar to that of today, we looked for historical two-year GDP growth patterns similar to what will likely occur in 2004 and 2005. S&P economist David Wyss expects that U.S. GDP will grow 4.6% in 2004 and 3.8% in 2005. We therefore screened for periods when GDP growth accelerated to more than 4% the first year and then slowed somewhat in the second year while still remaining close to 4%. This pattern occurred twice since 1990. The first took place in 1997, when GDP growth jumped 4.5% before easing slightly to 4.2% in 1998. Then in 1999, GDP re-accelerated to 4.5% before moderating to a still solid 3.7% pace in 2000. We then reviewed 77 materials sector funds (including multiple share classes) for their historical performance through June 30, 2004, and compared that with the performance of both the materials sector of the S&P 500-stock index and the S&P 500 itself.
