The U.S. economy contracted during the first quarter and will likely contract again during the second quarter. However, there are technical signs developing in the stock market to suggest investors may be looking beyond the US recession and maybe anticipating an economic recovery during the second half of the year. Recent rotations within economically sensitive sectors such as Consumer Discretionary, select Transportation stocks, select Industrials and now Materials indicate the market may be beginning to price in the reopening of the US economy.
The Materials sector still faces challenges including second-quarter earnings, COVID-19 pandemic, and US-China trade tensions. Companies in the Materials sector are involved in the discovery, development, and processing of raw materials. Since this sector supply most of the materials used in construction this sector is extremely sensitive to changes in the business cycle peaks and troughs.
Companies included in the Materials are chemical companies, building materials, paper products, mining, exploration, and processing. Improvements in these economically sensitive names can signal the reengagement in the manufacturing sector which is necessary for sustainable global economic growth. A declining US Dollar can also be a catalyst for the Materials sector as it acts as a tailwind to industrial metals or helps increase the demand for chemicals, which is the largest industry in the sector.
The sector is not out of the woods yet. However, since the expectations are incredibly low in this sector, and it is working from an extremely low base there may be selective investment opportunities available for patient and longer-term investors. Technical improvements are evidenced by the attached charts of the S&P 500 Materials sector (XLB), Relative Rotation Graph (RRG) of the 11 major S&P 500 sectors, and RRG chart of the components of XLB.