Why Haven’t Materials Joined the Rally?

China slowdown might already be rearing its ugly head

   

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What bull market? As the broader indices continue to make 52-week highs, one important sector — materials — has been conspicuously absent from the party.

Since the beginning of February, the Select Sector Materials SPDR (NYSE:XLB) has turned in a sluggish return of -0.38%, even as the S&P 500 has rocketed ahead by 6.37%. The relative performance of individual stocks in the sector is even more telling: Of the 40 largest stocks in the Dow Jones U.S. Basic Materials Index, no fewer than 32 have trailed the S&P 500 during the two-month period ended Wednesday.

Notable laggards within the group include copper miners — including Freeport-McMoRan Copper & Gold (NYSE:FCX), off 15.41% since Feb. 1 — select steel names, aluminum companies, fertilizer producers and gold miners. And that’s not all. The past six months also have brought meaningful underperformance for the transports, particularly railroads, as well as for the coal sector. Clearly, investors in stocks sensitive to the global economy haven’t been impressed by either the headline U.S. economic numbers or the strength in consumer spending.

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What’s going on here? A look at some key economic indicators shows that the underperformance of materials-related stocks might be more than just a case of investors rotating into technology and retail.

Consider the following:

  • Copper has settled into a lower range after peaking in early February, while nickel, steel and aluminum prices are all down from their year-to-date highs.
  • The Baltic Dry Index — although a less effective economic indicator now than it has been in the past due to increased shipping capacity — returned to its 2008 low in early February and has only recovered modestly from that level.
  • U.S. rail freight volume, after rising steadily from its 2009 low point, has been in a downtrend since October.

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Put all of these threads together, and the most logical explanation is that the strength in domestic consumption here in the United States is being offset by a slowdown in China. Although a few weeks back the Chinese government lowered its growth 2012 growth target to 7.5%, market performance is indicating that this might be optimistic.

Take the Brazilian iron ore producer Vale (NYSE:VALE), which sells more than 40% of its output to China and whose shares are down 11.2% from their Feb. 3 year-to-date high. Results such as these indicate that investors might need to start paying closer attention to the state of China’s economy. Indeed, the iShares Trust FTSE China 25 Index Fund (NYSE:FXI) also has underperformed the S&P 500 since the beginning of February.

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How long can the broader market extend its gains without the participation of the materials sector? For a clue, investors should keep their eye on how both XLB and FXI are trading relative to their 200-day moving averages. Even as all of the other sector ETFs have surged well above their 200-day MAs — the Select Sector Technology SPDR (NYSE:XLK), for example, closed Wednesday 16.7% above its 200-day MA — the XLB is in a much less favorable technical position. On Wednesday, XLB finished the day just 5.1% above its 200-day MA, leaving a narrow margin for error.

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Similarly, FXI has failed to surmount its 200-day moving average in convincing fashion, and it sat just 2.6% above this key level after Wednesday’s 3.2% shellacking.

The bottom line: While the rest of the world is marveling at the Nasdaq Composite’s move above 3,000, the smart money will be watching to see whether these two ETFs can hold their 200-day moving averages. If they can’t, it might be an indication that we’re in for a rocky second quarter.

As of this writing, Daniel Putnam did not hold a position in any of the aforementioned securities.


Article printed from InvestorPlace Media, http://investorplace.com/2012/03/why-havent-materials-joined-the-rally/.

©2014 InvestorPlace Media, LLC

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