The materials sector has been the worst-performing sector of the market for more than a year, but in the past week the group has finally begun to show signs of life. Although materials are a small segment of the market — weighted at just 3.3% of the S&P 500 — continued strength would be a very positive sign for the broader outlook.
First, a look at performance. Through April 15, the Materials SPDR (NYSE:XLB) had returned -0.2%, well below the 9.4% gain of the market as a whole, as gauged by the SPDR S&P 500 ETF (NYSE:SPY). That relationship has reversed in the six sessions through Thursday, during which XLB has returned 5.8% and comfortably outpaced the 2.2% return for SPY.
The primary reason for this turnaround is that the sector has finally been hitting on all cylinders, with all segments contributing positively to performance.
For the majority of this year, chemicals stocks Monsanto (NYSE:MON) and DuPont (NYSE:DD) have been keeping the sector afloat, even as mining, steel and agriculture remained weak. But in the past week, two chemical stocks that had previously lagged their peers — Dow Chemical (NYSE:DOW) and LyondellBasell Industries (NYSE:LYB) — have surged 12.6% and 9.7%, respectively. The beleaguered mining sector also has staged a strong rebound, reversing the trend of poor performance that has been in place since the start of the year.
New Highs Ahead?
The result is that XLB, which closed Thursday at $39.46, is now sitting just short of its 52-week high of $40.04. This will mark the sector’s third attempt to surmount the $40 mark so far in 2013. Investors can expect further gains if the ETF finally breaks through this level, but the move is unlikely to be extraordinary.
The last time XLB broke out, rising above the $38 mark on the first session of this year, it tacked on a total of 5.9% before pulling back — not bad, but not exactly a trade that will make your year. Further, key segments of the sector (most notably, mining and steel) all suffered major technical breakdowns in the very recent past. In this situation, the odds favor a retest of the lows over a straight-line recovery.
How likely is the materials sector to break out? For a clue, watch the 10-year Treasury note.
The rally in materials hasn’t been accompanied by a corresponding uptick in the yield on the 10-year — a divergence that suggests the move could prove unsustainable. If the 10-year starts to track the materials sector higher, that will be an indication that investors truly are feeling better about the growth outlook. If it remains mired in the 1.65%-1.75% range, however, it raises the likelihood that this is just a dead-cat bounce for materials stocks.
The Implications for the Broader Market
While the materials sector is small, it’s important to watch, as a new 52-week high in XLB would be a sign of broadening market leadership. Throughout 2013, the market has been lifted by the most defensive sectors, with the Health Care SPDR (NYSE:XLV, +19.7%), Utilities SPDR (NYSE:XLU, +18.2%) and Consumer Staples SPDR (NYSE:XLP, +17.8%) all outperforming the 11.8% gain of SPY by a substantial margin. On the other end of the spectrum, economically sensitive areas such as materials, industrials and energy have trailed the S&P.
Now, all three segments are within striking distance of 52-week highs, as measured by the SPDR ETFs.
Watch these sectors — and materials in particular, since it has been the weakest of the group — to see if they can indeed reach new highs in the coming weeks. If the cyclical market segments can assume some of the leadership burden currently being shouldered by the defensive sectors, it will indicate that investors are moving past the recent scare regarding global growth. And, not least, it would put a damper on the “Sell in May” talk that is sure to flood the airwaves in the next few weeks.
Investors still need to tread carefully with materials stocks given that the sector has provided more than its share of head-fakes in the past two years. Still, the sector’s ability to build on its gains of the past week could provide substantial insight regarding the direction of the broader market in the months ahead.
As of this writing, Daniel Putnam did not hold a position in any of the aforementioned securities.