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The Building Blocks of Industry and Construction

Article

As Madonna said in a 1984 hit, we are living in a material world.

© leva Zigg - stock.adobe.com

building blocks © leva Zigg - stock.adobe.com

As Madonna said in a 1984 hit, we are living in a material world. Nowhere is there a greater consciousness of this fact than among industrial companies.

To manufacture and package products, industry must have the necessary materials — many kinds, and lots of them. Materials companies produce the building blocks of manufacturing and construction — in some cases, quite literally. Purely and simply, you need stuff to make stuff, and to build plants to make stuff.

As the overall stock market morphs from a post-bear market to an embryonic bull, demand for manufacturing and construction materials is increasing, signaling distinct growth potential for this small but important sector.

Materials are the smallest of the stock market’s 11 sectors. The combined market capitalization of the entire sector is less than $900 billion, or about one-third the size of Apple (AAPL). The dominant ETF for materials, Materials Select Sector SPDR® ETF (XLB), holds shares of only 30 companies, totaling only about $5.2 billion in total value.

This may be the least understood sector for individual investors. Yet materials’ impact on the other 10 sectors is hard to overstate, because nothing gets manufactured, built or packaged without them. Materials companies comprise five different industry groups: metals and mining, chemicals, containers and packaging, construction materials and paper/forest products.

Sensitive Sector

As materials are highly economically sensitive, a recession would present a strong headwind for them. But more and more economists are toning down their earlier recession forecasts, with some now saying a recession widely forecast for this year or early next year may not happen. Of course, a recession is coming, just as another rainstorm is; the question is when. Doubtless, all the hair-pulling by recessionoid bears has suppressed materials prices even as the rationale for this negativity for 2023 has begun to wither.

Prices are so beaten down that, barring a highly unlikely Godzilla of a recession this year or early next (like the Great Recession of 2007-2009), they’ve really got nowhere else to go. After a rough 2023 thus far, materials’ stock prices are rock-bottom low, having lagged over the last 12 months (negative 9% vs. plus 4% for the S&P 500).

Amid this year’s doldrums, an isolated gust of wind has propelled some stocks in the sector in recent weeks — those of construction materials. This may puzzle folks who obsess over interest rates, but even with far higher mortgage rates this year, homebuilders have been doing quite well. (SPDR® S&P Homebuilders ETF (XHB) was up nearly 26% this year as of mid-June.) In a nation without enough places for people to live — the result of long-term under-building — the demand for new homes and residential construction materials has been quite brisk, driving up stock prices of Vulcan Materials, Martin Marietta Materials, Eagle Materials and Summit Materials.

Regarding the broader sector, if history is any guide, materials are likely to rise in the coming months. Historically, when materials have been in the first (or bottom) performance decile, as they’ve been recently, they’ve usually turned out to be the second-best-performing sector over the ensuing 12 months.

Drivers of the Materials Consumption Bus

In addition, various likely growth drivers point to likely near-term gains. These include:

  • The emerging trend of reshoring or onshoring. This is the practice of American companies relocating foreign plants to American soil to avoid supply chain disruptions from plant shutdowns in China and shipping bottlenecks like those that occurred during the pandemic. The acronym MAMA—for Make America Manufacture Again—is appearing with increasing frequency. This trend may turn out to be an epochal shift away from the 20th-century practice of American companies locating manufacturing plants abroad. If it lasts long enough, the onshoring trend could have a huge long-term economic impact by restoring a substantial number of the American jobs (including skilled ones) lost to the offshoring trend that started in the 1980s.
  • General economic impetus and onshoring impetus from financial incentives in federal legislation over the past couple of years. The $1.2 trillion Infrastructure and Jobs Act of 2021 thus far has resulted in the disbursement of more than $250 billion for thousands of construction projects now underway from coast to coast — roads, bridges, port facilities, broadband-access installations. Last year, Congress passed the $891 billion Inflation Reduction Act and the $200 billion Chips and Science Act, together creating financial incentives for projects in semiconductor manufacturing and clean energy — electric vehicle batteries EV development, solar energy equipment and green hydrogen. This development and manufacturing will require boatloads of materials. The construction of new plans and the commencement of manufacturing is expected to be relatively swift, as dozens of megasites (suitable land parcels of more than 1,000 acres) have already been chosen by manufacturers, most of whom are sticking to tight timelines. So great is the demand for such sites to capitalize on the financial advantages afforded by the three congressional acts that available land parcels are becoming a bit scarce — a good problem to have, really, and one that’s addressable with the usual solution: paying higher prices, which the legislation’s rich incentives would support.
  • Non-energy commodities now being at the outset of what’s known in this industry as a “super-cycle,” a long period of extended gains that follows years of flat performance. Historically, these upward periods have often lasted about 10 years. Commodities are a global business. Commodities may currently be mustering for such an uptrend as many nations are focusing on the shift to clean, renewable energy, spurring demand for non-energy commodities, including metals for EV batteries and other devices for storing electrical power. Increased manufacturing worldwide, following a global period of post-pandemic inflation and under-supply — specifically, increasing demand from the reopening of the economy in post-lockdown China — should boost demand for materials.
  • The indefatigable American consumer. Market bears fret about pessimistic consumer sentiment over the economy in recent years, somehow thinking that Americans will buy a lot less stuff. Yet, given the American penchant for spending, that’s like saying the swallows might not return to San Juan Capistrano. Recent data indicates that consumers aren’t losing their predisposition to spend. Results of the widely followed University of Michigan Consumer Sentiment Survey for May (released June 16) showed more-positive-than-expected consumer sentiment about the economy and the course of inflation.

Stock Picks

Among the holdings of the SPDR ETF LB are some with relatively low fundamental risk levels and good prospects for growth over the next few years, including: Corteva, Dow, Ecolab, Linde plc, Martin Marietta Materials, Nucor, PPG Industries, Sherwin-Williams, TimkenSteel Corp., Clearwater Paper Corp., FMC, Greif Inc. Class A, SunCoke Energy, Olin Corp. and Sylvamo Corp. Most of these companies are the market leaders in their particular industries.

The low-risk profiles and earnings growth forecasts of these companies will likely make them participants in a broader manufacturing growth trend of the developing bull market, one that got a toehold in June after these inhibitors abated or disappeared: investors’ regional-bank fears (which have pretty much dissolved); the resolution of the federal debt-ceiling crisis; and, regardless of whether Federal Reserve Board raises interest rates another time or two, the now-in-sight end of the current cycle of stock-crimping rate hikes. With these issues out of the way, the broad market can grow, following tech stocks in the Nasdaq exchange, which typically leads the overall market into a bull. The Nasdaq reached bull market status in March, having then grown 20% in 2023.

The stage seems set for a sustained rise in industrial and consumer manufacturing. Unless the universal laws of physics change, we will need more stuff to make more stuff in this highly material world.

Dave Sheaff Gilreath, CFP®, is a founding principal and CIO of Sheaff Brock Investment Advisors, an investment firm for individual investors, and Innovative Portfolios®, an institutional money management firm. Based in Indianapolis, the firms manage assets of about $1.3 billion. The companies mentioned in the article may be held by those firms, Innovative Portfolios’ ETFs, affiliates or related persons. There may be a conflict of interest in that the parties may have a vested interest in the companies and the statements made about them.

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