It’s been night and day for materials stocks in 2012. Many stocks in this sector popped early in the year, but have dropped hard recently to right where they were back in December.
So what’s going on? Simply put, many investors are worried the recovery is running out of gas — or worse, that it never was a recovery at all.
As America struggles, regions of Europe slip into recession and China starts to slow down, many are afraid materials companies will see already meager demand dry up and send these companies even lower.
Consider this: Alcoa (NYSE:AA) hasn’t traded under $8.40 since May 2009. And ArcelorMittal (NYSE:MT) hasn’t traded this low since 2004!
Do we really think these companies are worse off now than back then? Do we really want to ignore that when Alcoa was last priced this low in 2009, as demand was weak and the company was restructuring, it delivered a 35% gain across the next 12 months?
I just don’t get it. Yes, there are many risks to the global economy out there. Yes, we’ve known about weak aluminum and steel demand for years. Yes, we’ve been on the eurozone death watch for months. The story of China’s slowdown, the softness in housing … I get it.
But what’s new here?
Rather than focus on old headlines, I’m interested in the momentum that Alcoa and ArcelorMittal are gaining compared with their crisis-level lows. And you should be too, now that shares are priced at the same levels or lower.
Consider that Alcoa slashed its global work force by 13% in 2009, laying off a massive 13,500 workers. ArcelorMittal also laid off thousands of workers in 2009, cutting output to just 70% of capacity back then and regularly idling facilities to bleed down oversupply ever since.
The restructuring has made both companies soundly profitable once more. And believe it or not, they actually are seeing glimmers of growth.
Alcoa has seen nine straight quarters of year-over-year revenue increases. ArcelorMittal has seen seven in a row. Admittedly, both stocks are forecast to see slight earnings declines in 2012 compared with 2011 if forecasts hold — but those numbers are light-years ahead of 2009. Also, both AA and MT are right around 52-week lows, so it’s hardly like you’re buying a top before a flop.
More good stuff for ArcelorMittal: The steel giant has a forward P/E of less than 5 right now — and a 4.5% dividend to boot!
And for Alcoa: Aluminum buyers in Japan, Asia’s largest importer, just agreed to pay a record premium to aluminum producers next quarter as the nation continues to ramp up its industries and rebuilds in the wake of the disastrous earthquake and tsunami last year. This reinforces my belief that between baseline demand and minimal output, base metal prices like aluminum and steel have nowhere to go but up.
There are risks in these stocks, to be sure. Lingering conflicts between management and union efforts at ArcelorMittal threaten disruptions to the business or increased labor costs. And Alcoa posted its first quarterly loss since 2009 in its fiscal fourth quarter as metal prices tumbled.
There also are some bigger-picture risks to acknowledge for these stocks and the sector in general:
- Materials stocks are volatile, so even if we see a rally in these stocks across the next few months, it might not last long — as we saw with the jump in the first eight weeks of the year that evaporated just as quickly.
- Inflation and the dollar can have a big factor on metal prices and the profitability of these companies. Many people (justifiably) think that the dollar’s current strength is simply due to the disaster in Europe rather than the merit of the U.S. itself, and it will only take a few more stupid debt ceiling headlines to change that in a hurry.
- As many will point out, some of the previous rallies in equities were based on Fed action or sentiment rallies, so investing based on logical assumptions or fundamental trends might never amount to anything.
- Then there are the Armageddon scenarios where a eurozone meltdown obliterates the global economy — but if you believe that’s the case, frankly, you should be building a bunker instead of reading this article.
However, even with those factors in play, I think the bottom line is that materials stocks like Alcoa and ArcelorMittal are the ultimate cyclical stocks. When the economy ramps up, construction rebounds and durable goods are in demand, these companies will take off.
I, for one, think that a year or two from now we will be in a true self-sustaining recovery — and that means AA and MT are bargains.
Maybe you think it’s a Pollyanna outlook to expect that a recovery is coming at all in the next few years, or maybe you think it’s naïve to say Alcoa and Arcellor Mittal have “right-sized” themselves enough to weather any short-term difficulties in the next six months. If so, I would love to hear from you and have you make your case. Please share your thoughts below in the comment section or drop me a line at firstname.lastname@example.org.
But to me, I think it’s a relatively low-risk investment to tread water in AA or MT and wait for sunnier times to lift shares. That’s why I personally own Alcoa stock and think AA is your best stock to hold for the rest of 2012.
Jeff Reeves is the editor of InvestorPlace.com and the author of “The Frugal Investor’s Guide to Finding Great Stocks.” Write him at editor@investorplace??.com or follow him on Twitter via @JeffReevesIP. As of this writing, Jeff Reeves owned a position in AA.