The Materials Select Sector SPDR (NYSEArca: XLB) and other materials ETFs are performing admirably this year. For example, XLB, the largest materials ETF by assets, is up 19% year-to-date.
Rivals to XLB include Vanguard Materials ETF (NYSEArca: VAW) and Fidelity MSCI Materials Index ETF (NYSEArca: FMAT). Due to their close ties with the commodities market, materials stocks and ETFs are susceptible to cyclical demand and volatility in raw material and energy prices. While the sector’s sensitivity to business cycles can expose investors to greater risks, the area may also offer attractive returns during periods of strong growth.
However, now could be a good time to consider the often overlooked materials sector. Historical data indicate XLB is one of the two best sector SPDR ETFs to own in December and January. Plus, cyclical sectors, of which materials certainly is one, often perform well as interest rates rise. The Federal Reserve is widely expected to raise interest rates when it meets later this month.
Importantly, an array of fundamental factors look good for materials stocks.
“In the metals and mining part of the sector, many issuers took aggressive steps to reduce debt balances that included asset sales and equity issuances. The debt reduction along with better prices for mined commodities and margins for metals has resulted in issuers being upgraded or possessing positive outlooks,” according to Morningstar.
Additionally, there is the prospect of increased mergers and acquisitions activity in some parts of the materials universe.
“The chemicals portion of the sector remains stable as result of consistent demand and pricing. We expect continued stability unless a recession occurs. We also see the potential for M&A due to the consistent free cash flow profiles of many chemical issuers and the still low interest rates available to many corporate borrowers,” notes Morningstar.
Investors have added over $272 million to XLB since the start of the fourth quarter.
The Guggenheim S&P Equal Weight Materials ETF (NYSEArca: RTM), which equally weights components and includes a larger tilt toward smaller U.S. companies, holds larger tilts toward construction materials sub-sector.
For more information on the materials sector, visit our materials category.