Buying the shares of the companies that produce basic materials for the industrial economy has been a great bet during the past year. The S&P 500 Materials Index has been one of the top performers over the last year as demand for commodities, like copper to aluminum, have surged.
After this powerful rebound from the COVID-19-triggered recession, analysts believe there are more gains to come. The latest indication that this record rally has more room to run came from Alcoa (NYSE:AA), the US' largest producer of aluminium.
The company this week reported its first-quarter earnings that beat analysts’ expectations. It also projected further gains ahead as economies reopen. Shares of Alcoa have skyrocked since last April, jumping more than 350%. They closed Thursday at $33.21.
“Alcoa is expecting a strong 2021 based on continued economic recovery and increased demand for aluminum in all end markets,” the Pittsburgh-based company said in its earnings statement. The company’s aluminum segment is forecasting double-digit growth on year-over-year sales of value-added products.
Alcoa Chief Executive Officer Roy Harvey said last month that China is taking meaningful steps to rein in production, calling it a “game-changer” for the industry after years of gluts.
Shares in companies like copper miner Freeport-McMoRan (NYSE:FCX) and Dow Inc (NYSE:DOW) have soared on commodity price increases, helping to push the S&P 500 Materials Index up 73% during the past 12 months.
A Boon To Corporate Profits
Strong demand for raw materials, on the other hand, is pushing costs for companies, from home builders to clothing makers. If history repeats, that will be a boon to corporate bottom lines and investors as well, according to a recent report in the Wall Street Journal.
The report, citing Scott Colyer of Advisors Asset Management, said commodity prices and, in turn, the price of manufactured goods have room to run, thanks to fiscal and monetary stimulus from governments aiming to soften the blow of pandemic lockdowns and revive their economies.
“Meanwhile, scarcity of some materials and snarled supply lines have purchasing managers stockpiling the materials their companies need to do business, which adds more demand,” the report said.
The revival in these companies’ fortunes is, of course, very much dependent on the trajectory of the pandemic and how the major industrial economies come out of this health crisis. Despite the surging COVID cases globally, economists still believe the faster vaccine rollouts will help contain the virus.
US real GDP is due to expand 5.7% in 2021, up from a 3.5% decline in 2020, according to data compiled by Bloomberg. Likewise, in China—one of the biggest consumers of raw materials—real GDP is expected to expand 8.5% in 2021, up from last year’s 2.3%. Canada’s central bank said Wednesday it plans to scale back its monetary stimulus as the economy is expected to rebound strongly this year.
Analysts at Jefferies wrote in a note last month that their analysis shows that end-market demands are continuing to improve from a low last year, supporting their view that materials could continue to lead the market through 2021 as their valuations are still attractive.
“The main reason why materials are not getting more expensive in both large and small [stocks] despite strong performance is that earnings estimates are really moving higher,” they wrote in a note published by Bloomberg. Some of the top picks within materials for Jeffereies include Freeport, Univar (NYSE:UNVR) and Linde (NYSE:LIN).
Bottom Line
Buying the shares of companies that produce raw materials for the industrial economy has been a profitable bet over the past year. This rally in materials has more upside as the global economy is expected to overcome the pandemic and GDP growth accelerates.