We talked a little last week about the post-pandemic sector map and how Big Tech needs time to refresh, while brick-and-mortar stocks risk getting ahead of themselves.
Now, let’s focus on an area of the market that deserves to lead Wall Street from here. The COVID-19 outbreak was only a fleeting interruption for materials-producing companies. From chemicals to mining, commodity stocks are tracking 28% higher earnings from 2019 to 2021.
That’s faster two-year growth than any other sector, including technology itself. As the noise around the pandemic recedes, the trend here is clear. And if you believe (like I do) that earnings ultimately drive shareholder wealth, the bulls have a lot to cheer in that growth trend.
Why Tech Lost Its Way
Of course, growth often comes at a price, which is why the clouds have gathered over Silicon Valley now. While Big Tech prospered in the pandemic, even their accelerated earnings expansion struggled to keep up with the stocks.
This is more than a feeling. The classic “strong buy” signal flashes when a stock carries a higher growth rate than its earnings multiple. Right now, technology stocks are a little below that threshold.
There are exceptions, as giants like Amazon.com Inc. (NASDAQ:AMZN) remain priced at bargains relative to their growth, but on the whole, the Nasdaq simply looks a little expensive.
That’s a problem when Wall Street has gotten into the habit of trading tech as a proxy on the pandemic economy. As vaccinations spread and people start getting out of the house, money needs to flow out of some of these companies.
Apple Inc. (NASDAQ:AAPL) and its peers are going to need at least a few months to change that narrative. In the meantime, the brick-and-mortar world is where Wall Street wants to go now.
Literal Bricks, Literal Mortar
Technology has become so ubiquitous in our lives that the traditional materials sector now accounts for less than 3% of the S&P 500 by market capitalization. But this is where the action is.
The housing boom and looming infrastructure program have triggered enormous interest in construction supplies companies. Inflation, meanwhile, has been a boost for precious metals and other miners.
Add it all up, and that’s how you get the 28% earnings lift across the pandemic. From bricks to copper to cement to chemicals, this 3% of the market is where the heat is.
And even so, the sector as a whole is still priced at less than 20X forward earnings. Higher growth than multiple? That’s a buy.
Of course, a lot of earnings expectations for 2021 and beyond are built around Congress agreeing to spend money on roads and other infrastructure. There’s always a risk that won’t happen.
But lumber, copper and other materials are in short supply because residential construction is as hot as it gets. That isn’t a factor of top-down politics. It’s happening, even as we speak.
And if you’re concerned about inflation ahead, commodities are the place to park money and preserve purchasing power. The sector is attractive on those terms.
Avoid the Biggest Producers
We buy stocks. Looking at the materials sector, I’m not impressed with giants like Linde PLC (NYSE:LIN) and Sherwin-Williams Co. (NYSE:SHW).
While all corners of America are buying paint right now, SHW is already feeling the pressure of inflation in its own supply chain. Even though sales are up 8% this year, earnings are going in the wrong direction.
And while LIN makes the chemicals, 20% earnings growth this year isn’t enough to justify a 30X multiple. Great company. Overextended stock.
Air Products & Chemicals Inc. (NYSE:APD) is less of a prize at only 8% growth weighed against 36X earnings. Chemicals are hot but, like Big Tech, the stocks have simply been too hot.
What do I like? Freeport-McMoRan Inc. (NYSE:FCX) is the leading copper producer on the planet. Earnings are tracking 400% higher this year and that’s off a big growth base.
The stock is available for barely 14X earnings. I’d rather be here than in AMZN.
CANNABIS CORNER: THE OVERSOLD BOUNCE
Volatility can be our friend, as well as a drag. This week, Big Cannabis had what it took to outperform the S&P 500, thanks to a basic rule of market physics.
Stocks like Aurora Cannabis Inc. (NYSE:ACB) plunged to statistically improbable levels in recent weeks, but statistics is a field where exaggerated moves in either direction always correct sooner or later.
That’s what happened this week. Canopy Growth Corp. (NYSE:CGC) and Tilray Corp. (NASDAQ:TLRY) joined the rally as well.
The fundamentals for the group didn’t change much. Only the charts stretched too far to the downside. Now that they’re snapping back, I’m eager to see how far the rally goes.
After all, every bull run starts with a bump. Some stop there. But when a stock really gets rallying, we can all cheer.
Either way, my subscribers in IPO Edge don’t buy the majors or trade for instant gratification. We’re in small names for a holding period that can be measured in months, not minutes.
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