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Materials: Ready for a potential economic rebound

Key takeaways

  • The materials sector tends to be closely tied to the economic cycle—rising and falling with the overall state of economic growth.
  • In the past year, the sector delivered positive but sluggish returns, reflecting concerns over recession risk.
  • However, historically the sector has performed well in the early stages of new economic growth, and so could be well positioned for any eventual economic recovery.
  • I have found long-term investment potential in a number of segments of the sector that have shown favorable supply-and-demand dynamics, including among copper miners and US chemical manufacturers.

Many forces and drivers impact the materials sector. But over the past year or so, one driver has been preeminent: the state of the economy.

As a cyclical sector, materials stocks tend to rise and fall with the broader economy. And with the economy seemingly perched on the precipice of recession for more than a year, materials stocks have not been in favor.

However, the economic cycle will inevitably continue to evolve in 2024. Any eventual economic brightening could act as a catalyst for the stocks. And favorable supply-demand dynamics in some areas of the sector could set up a constructive outlook for the year ahead.

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A positive, but slow, past year

The materials sector encompasses industries such as chemical producers (including makers of fertilizers and industrial chemicals), metals producers (including gold and copper miners and steelmakers), makers of construction materials (such as cement, bricks, glass, and gravel), and producers of wood-based goods (such as lumber and paper packaging). These industries operate in global markets, and demand for these goods tends to be highly dependent on the state of the broader economy. For example, construction materials are likely to be in higher demand when the economy is booming. For that reason, materials are inherently a cyclical sector, meaning they tend to move in sync with the economy.

In 2023, the sector’s performance reflected this close relationship. Like the broader economy, the materials sector still eked out positive growth. But like the broader economy, the sector’s performance was sluggish—hampered by investor concerns over recession risk.

Chart shows year-to-date price performance of the materials sector, compared with that of the S&P 500. As of December 8, 2023, the materials sector had gained 4.96%, compared with the 19.92% gain of the S&P.
Past performance is no guarantee of future results. Materials sector performance is represented by the S&P Materials Select Sector Index. Data as of December 8, 2023. Source: S&P Dow Jones Indices, a division of S&P Global.

While the sector lagged the double-digit returns of the S&P 500®, it’s important to remember that the S&P’s gains were disproportionately driven by a handful of mega-cap growth stocks—particularly companies in the technology and communication services sectors that were seen as plays on the rise of artificial intelligence. Amid such narrow leadership, materials simply didn't shine.

Looking beyond short-term economic sensitivity

For 2024, the sector’s performance may continue to be driven primarily by macroeconomic issues. And to be sure, if a recession finally materializes, it could weigh on the stocks over the short term. But eventually a new cycle of economic growth is likely to emerge—whether after a recession or after a so-called “soft landing”—which could benefit materials stocks.

In managing Fidelity® Select Materials Portfolio (), I focus on finding areas of the sector with the most attractive supply-and-demand dynamics, and establishing fairly concentrated positions in those areas. For example, compared with its benchmark, the fund had recently maintained a significant overweight in copper producers, while avoiding investments in lithium miners. This may seem counterintuitive, because both of those metals are key inputs in the development of electric vehicles, and both are expected to see strong demand growth in the coming years from the long-term transition to EVs.

The difference between the two, in my view, is in their respective supply profiles. Copper supply has been challenged for some time now, and could become increasingly tight in the years ahead. Copper mines are aging, and the quality of the ore produced has been decreasing in key producing countries like Chile and Peru. Although demand for copper dipped a bit this past year due to China’s economic headwinds, I believe that an eventual pickup in demand could trigger a rally in copper prices, because supply will be tight. Freeport-McMoRan () is one of the world’s largest suppliers of copper, and is a recent fund holding that has exemplified this investing thesis.

By contrast, there is really no shortage of lithium, and there are new industry entrants that will likely further increase supply going forward. So even if demand grows as expected, I don’t believe the long-term picture for commodity prices is as attractive for lithium as it is for copper.

Fund top holdings1

Top-10 holdings of the Fidelity® Select Materials Portfolio () as of October 31, 2023:

  • 23.9% – Linde PLC ()
  • 6.6% – Freeport-McMoRan ()
  • 5.9% – LyondellBasell Industries ()
  • 5.2% – Air Products & Chemicals Inc. ()
  • 4.3% – CF Industries Holdings Inc. ()
  • 4.3% – DuPont de Nemours Inc. ()
  • 4.1% – Corteva Inc. ()
  • 3.7% – Celanese Corp. ()
  • 3.3% – The Chemours Co. ()
  • 3.3% – AptarGroup Inc. ()

(See the most recent fund information.)

Potential opportunities in chemicals and gasses

Elsewhere in the portfolio, I’ve recently identified opportunities in a group of US chemicals companies, particularly within the commodity chemicals segment. These are chemicals made on a large scale and used to produce other chemicals, which, in turn, are used to produce a range of end-user products, including construction materials, adhesives, plastics, and more.

Many of the US firms in the segment employ natural gas in their manufacturing processes, which gives them a cost advantage over their European counterparts, who use oil. US energy prices are generally lower than those in Europe, and this difference is even greater when comparing US natural gas to European oil. These cost advantages have translated into pricing advantages for US companies, which I believe could help this group gain market share and sales. Recent fund holdings among such US chemical producers have included LyondellBasell Industries (), Olin (),2 and Cabot ().3

Lastly, while I tend to focus the fund on stocks I believe are poised to benefit from the economic cycle, I also try to maintain stability in the portfolio via steady, non-cyclical companies, as long as they are in what I consider to be improving end markets. Industrial gas company Linde () is an example of a recent portfolio holding that has demonstrated this investing thesis. The company has had sticky, long-term contracts in diverse end markets. It could also be a play on global energy transition trends, particularly in the area of carbon capture.

Focusing on stocks with favorable supply-demand profiles

Materials stocks could remain in a holding pattern until the Fed and other central banks end their rate-hiking cycles and start lowering interest rates.

While I can’t control what the Fed or the economy will do, I can control the fund’s positioning. With that in mind, I have aimed to position the portfolio for the eventual upturn in the economic cycle that may occur if or when rate cuts begin. Some materials stocks have traded at depressed valuations, and I’ve been able to establish or add to holdings in well-positioned companies at inexpensive prices in recent months. I may continue to seek areas of the sector that I believe have the strongest supply-and-demand profiles, and which I believe could respond well to a growth rebound.

Ashley Fernandes, CFA
Natural Resources Sector Leader/Portfolio Manager

Ashley Fernandes is the Natural Resources sector leader and a portfolio manager in the Equity division at Fidelity Investments. Fidelity Investments is a leading provider of investment management, retirement planning, portfolio guidance, brokerage, benefits outsourcing, and other financial products and services to institutions, financial intermediaries, and individuals.

In this role, Mr. Fernandes provides research coverage for the global integrated energy and global mining companies and he manages the Fidelity Natural Resources Fund. He is also a member of Fidelity's Stock Selector Large Cap Group and is responsible for managing the energy and materials sleeves for various diversified sector-based portfolios. Mr. Fernandes is also responsible for co-managing the Fidelity and Fidelity Advisor Balanced Funds, VIP Balanced Portfolio, Fidelity Select and VIP Materials Portfolio, and Fidelity Advisor Materials Fund. Additionally, he co-manages both the global energy and global materials sector sleeves of the FIAM sector portfolios.

Prior to assuming his current role, Mr. Fernandes worked as a global energy analyst for Fidelity International Limited (FIL) in London from 2008 to 2013. In this capacity, he was an analyst for the U.S., Canadian, European integrated, and emerging-market energy sectors, as well as small- and mid-cap international exploration and production (E&P) companies.

Before joining Fidelity in 2013, Mr. Fernandes worked as an associate in Private Equity. He has been in the financial industry since 2001.

Mr. Fernandes earned his bachelor of commerce degree, with honors, from Queen’s University, and his master of business administration degree from London Business School. He is also a CFA® charterholder.

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Before investing, consider the funds' investment objectives, risks, charges, and expenses. Contact Fidelity for a prospectus or, if available, a summary prospectus containing this information. Read it carefully. 1. Any holdings, asset allocation, diversification breakdowns or other composition data shown are as of the date indicated and are subject to change at any time. They may not be representative of the fund's current or future investments. The Top Ten holdings do not include money market instruments or futures contracts, if any. Depository receipts are normally combined with the underlying security. Some breakdowns may be intentionally limited to a particular asset class or other subset of the fund's entire portfolio, particularly in multi-asset class funds where the attributes of the equity and fixed income portions are different. Under the asset allocation section, international (or foreign) assets may be reported differently depending on how an investment option reports its holdings. Some do not report international (or foreign) holdings here, but instead report them in a "Regional Diversification" section. Some report them in this section in addition to the equity, bond and other allocation shown. Others report international (or foreign) holding as a subset of the equity and bond allocations shown. If the allocation without the foreign component equals (or rounds to) 100%, then international (or foreign) is a subset of the equity and bond percentage shown. 2. Fidelity® Select Materials Portfolio (FSDPX) held a 1.89% position in this stock as of October 31, 2023. 3. Fidelity® Select Materials Portfolio (FSDPX) held a 2.69% position in this stock as of October 31, 2023.

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Past performance is no guarantee of future results.

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Stock markets are volatile and can fluctuate significantly in response to company, industry, political, regulatory, market, or economic developments. Investing in stock involves risks, including the loss of principal.

Because of its narrow focus, sector investing tends to be more volatile than investments that diversify across many sectors and companies. Sector investing is also subject to the additional risks associated with its particular industry.

The materials industries can be significantly affected by the level and volatility of commodity prices, the exchange value of the dollar, import controls, worldwide competition, liability for environmental damage, depletion of resources, and mandated expenditures for safety and pollution control.

The S&P 500® Index is a market capitalization-weighted index of 500 common stocks chosen for market size, liquidity, and industry group representation to represent US equity performance. The S&P Materials Select Sector index comprises those companies included in the S&P 500 that are classified as members of the materials sector, with capping applied to ensure diversification among companies within the index.

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