The rebound in U.S. materials stocks is likely to fizzle, undermined by China’s capital spending slowdown and the surge in natural gas input costs.
Our U.S. equity strategists have been overweight S&P Materials as part of the deep cyclical sector bias, but are losing confidence that the recent uptrend can be sustained.
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Technical conditions are overbought. Our Technical Indicator is closing in on previous bullish extremes, and is challenging levels that have previously marked interim relative performance peaks. The advance has also occurred on narrow breadth. The number of groups with a positive 52-week rate of change is lagging behind relative performance, as is the number of groups trading above their 40-week moving average. Spotty participation suggests that the latest advance is not well supported.
Importantly, China is struggling to maintain a high rate of economic growth. Infrastructure spending has slowed significantly, and its currency has begun to decline. Money growth is sinking and loan growth is decelerating, underscoring that a sudden resource-intensive reacceleration in Chinese economic growth is unlikely. This is a headwind for the materials sector.
Sluggish Chinese economic data, persistent softness in emerging market leading economic indicators, contracting materials exports and surging natural gas prices, a key input cost, are weighing on our Cyclical Macro Indicator. The message from the CMI is that relative forward earnings estimates are unlikely to sustain upward momentum. Consequently, the prudent portfolio strategy is to pare our materials sector weighting to neutral.
