Key Takeaways
- Materials are a cyclical sector, meaning the stocks generally rise and fall with global growth prospects.
- Concerns over global recession risks could continue to weigh on the stocks in 2023, but the sector has historically performed well during cyclical recoveries.
- That said, the sector still holds a number of potentially compelling long-term opportunities, including copper miners and chemical manufacturers.
In the past year, and likely in the coming year, the main force driving the materials sector has been recession worries.
However, there are attractive pockets of potential long-term opportunity in the sector—such as among firms that stand to benefit from the long-term transition to electric vehicles. For such long-term trends, the market's downturn of the past year has presented some potential buying opportunities.
Riding a slowing global growth outlook
The materials sector encompasses industries such as chemical producers (including makers of fertilizers and industrial chemicals), metals producers (including gold and copper miners and steelmakers), makers of construction materials (such as cement, bricks, glass, and gravel), and producers of wood-based goods (such as lumber and paper packaging).
Demand for those goods tends to be highly dependent on the state of the broader economy. For that reason, materials are inherently a cyclical sector—meaning they tend to boom and bust in step with the broader economy. The end market for materials is generally global in nature—one ton of copper mined in Canada could be sold in North America or shipped to Asia. That means the stocks react not only to US growth prospects but to global growth prospects.
Source: Past performance is no guarantee of future results. Materials sector performance is represented by the S&P Materials Select Sector index. Data as of Dec. 9, 2022. Source: S&P Dow Jones Indices, a division of S&P Global.
In the past year, the confluence of global growth worries weighed on the materials sector. While the US economy remained surprisingly resilient during 2022, there's no question that growth has slowed and recession risks for 2023 have risen. China's repeated COVID-related lockdowns weighed on the country's growth, as has its weak property market. And parts of Europe seem already to be tipping into recession, as a result of rising food and energy prices due to the war in Ukraine.
While these headwinds are likely to persist into the coming year, some specific materials segments have still been showing strong long-term fundamentals.
The early stage of a long-term story for copper
Take copper, for example. The metal's price declined considerably in 2022 on growth concerns related to a potential global slowdown and China's COVID policies. Yet the long-term supply-demand picture for copper looks compelling, as the metal is a play on a powerful trend that is still in its early stages: "the electrification of everything." Notably, electric vehicles (EVs) use significantly more copper than vehicles with internal combustion engines.
Source: IEA 2022; "Executive summary: The role of critical minerals in clean energy transitions," License: CC BY 4.0.
Long-term opportunity amid a short-term slowdown
Similarly, certain parts of the commodity chemicals group could have compelling long-term potential despite the short-term growth slowdown.
This segment includes chemicals that are made on a large scale and that act as intermediates to produce other chemicals—which, in turn, are used to produce an extensive range of end products, including construction materials, adhesives, plastics, apparel, and tires.
Demand in the group tends to be sensitive to broader economic trends. While the growth outlook for 2023 is uncertain, the longer-term outlook—like for the next three to five years—looks more constructive. If the economy eventually improves, as the pandemic continues to recede and global economies recover from the current slowdown, producers of commodity chemicals could see rising demand for their products.
Moreover, short-term supply constraints for these products could drive attractive pricing dynamics. The war in Ukraine has pushed up feedstock and energy costs for chemical producers in Europe, putting them at an increased disadvantage compared with competitors outside of Europe. And capacity growth could decelerate in the United States in coming years.
On the lookout for supply-demand imbalances
In addition to those broader themes, other unique opportunities could arise in the sector. Among the various industries and sub-industries within the materials sector, supply-demand dynamics can at times be thrown into stark imbalance—presenting potential opportunity for savvy investors.
While 2023 may bring continued challenges for markets and materials in the big picture, there still may be some positive long-term stories for investors willing to dig deeper.