As 2017 enters the homestretch, the S&P 500 Materials sector has surged ahead and become the second-best-performing sector in the S&P 500.
Up 18.4% ytd, Materials still trails the Tech sector, but it has broken away from the other S&P 500 sectors, even edging past Health Care.
Here’s the performance derby for the S&P 500 sectors ytd through Tuesday’s close: Tech (35.7%), Materials (18.4), Health Care (17.7), S&P 500 (15.0), Financials (14.1), Utilities (13.2), Consumer Discretionary (13.0), Industrials (12.5), Real Estate (5.4), Consumer Staples (2.8), Energy (-9.3), and Telecom Services (-16.1) (Fig. 1).
The outperformance of Materials owes much to the expected surge in demand for lithium, related to the anticipated move to electric vehicles from those run by the gasoline-fueled combustion engine.
Here’s a quick look at what’s pushing this sector materially higher:
(1) Summer surge. The Materials sector’s acceleration started in late summer. From August 15 through Tuesday’s close, the sector returned 9.4%, on par with the Tech sector’s market-leading 9.91% return.
Ironically, the Materials sector isn’t being driven by companies selling raw materials. After a strong rally from mid-2015 to mid-2016, the CRB raw industrials index has flat-lined in recent months, albeit near its highest levels. It’s up only 0.6% ytd (Fig. 2). Accordingly, the S&P 500 Steel industry index has fallen 2.8% ytd, while Copper (6.0%) and Gold (6.1%) are up by mid-single-digit levels. Instead, the Materials sector is being propelled higher by Specialty Chemicals, up 29.0% ytd, Diversified Chemicals (24.9%), Industrial Gases (18.0), and Fertilizers & Agricultural Chemicals (15.3) (Fig. 3).
(2) Thank the chemicals. Within the Specialty Chemicals industry, the standout performer is Albemarle, which gets roughly a third of its revenue from the production and sale of lithium. Its shares are up 63.7% ytd through Tuesday’s close, propelled by hopes that electric cars will become commonplace and the demand for lithium batteries will soar.
The second-best-performer in the Specialty Chemicals industry is Sherwin-Williams, up 47.0% ytd. It has benefitted from the boom in housing and its acquisition of Valspar. The deal helped Sherwin report a Q3 37.4% jump in sales y/y to $4.5 billion. Earnings per share in Q3 fell to $3.33 from $4.08 a year earlier; however, that includes a $1.42 a share charge for acquisition-related costs and 27 cents of expenses and lost sales related to the hurricanes. PPG Industries—another industry member that also produces paint in addition to coatings and specialty materials for industries like automobiles and aerospace—is up 22.7% ytd.
Since the start of the year, analysts have been boosting their expectations for revenue and earnings growth in the Specialty Chemicals industry. It’s now expected to grow revenue by 8.7% and earnings by 14.5% over the next 12 months (Fig. 4). The industry’s forward P/E also has climbed, to 22.5 from a low of 18.0 in January 2016 (Fig. 5).
(3) More lithium. The S&P 500 Fertilizer & Agricultural Chemicals industry stock price index has helped the Materials sector move ahead as well. Momentum comes less from the farm and more from the need for batteries. The shares of fertilizer producers CF Industries and Mosaic are up 20.7% and down 23.8%. Meanwhile, the shares of Monsanto, which sells seeds and herbicides to farmers, have climbed 15.1%.
But that pales in comparison to the 64.2% ytd gain in FMC’s shares. Like Monsanto, FMC produces herbicides and other products for the agricultural market. That segment kicked in $583 million in Q2, or 88.7% of total revenue. The lithium segment generated $74 million of revenue, or 11.3% of the total, but that may be where investors are focused. Last year, FMC announced plans to triple its lithium production by 2019 in response to the “rapid growth of electric vehicle sales and strong demand for FMC’s battery grade lithium hydroxide.”
Analysts expect FMC’s earnings will jump to $5.15 a share in 2018, up from $2.43 this year. Because of the major jump expected in earnings, FMC shares trade at 18.0 times 2018’s estimated EPS despite their strong run. Earnings growth is expected to slow sharply in 2019, to 13.6%.
The S&P 500 Fertilizer & Agricultural Chemicals industry is expected to see revenues grow by 9.8% and earnings jump by 20.3% over the next 12 months (Fig. 6). And its forward P/E, at a recent 23.4, looks reasonable compared to prior booms (Fig. 7). Just remember that developments with electric vehicles may affect this industry more than events down on the farm.
Dr. Ed Yardeni is the President of Yardeni Research, Inc., a provider of independent global investment strategy research.
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