Steel stocks have been showing relative strength in December following a few months of underperformance. So far this month, the VanEck Vectors Steel ETF (NYSE: SLX) is up 5%, while the S&P 500 (NYSE: SPY) is up 0.5%. However, steel stocks have been trending lower since May 10 when many second derivative, economic growth measures peaked.
Overall, the steel industry ETF is down 23% from its high in May of this year. Another factor in the weakness of industrial metals is the Chinese economy decelerating and increasing concerns of systemic risk with the Evergrande default.
However, there are some silver linings that make the sector worthy of consideration for an investment or a trade.
The first is that valuations are quite attractive. This is evident if we look at some of the leading stocks in the sectors like ArcelorMittal (NYSE: MT), Nucor (NYSE: NUE), or Posco (NYSE: PKX) which are trading at single-digit P/Es with forward P/Es that are also about half that of the S&P 500.
Such low valuations only make sense if investors are expecting some sort of slowdown in earnings and revenue. But, so far, earnings have continued beating expectations. This circumstance of earnings growth, while the stock price trends lower, is not sustainable. In general during bull markets, buying stocks with increasing earnings on dips of more than 20% tends to be rewarded.
If we look at EPS estimates for the 3 biggest stocks in the sectors, we see that in 2021, MT's 2021 EPS forecasts went from $2 per share to $13 per share now. Similarly, NUE's and PKX's EPS forecasts have increased from $7 per share to $14 and NUE's forecasts have gone from $4 per share to $23 per share.
However, 2022 EPS forecasts are currently running about 30% to 40% lower than 2021. However, it's also possible that analysts will continue to underestimate these companies' earnings power as they did for much of 2022.
Finally, the latest development is the constructive and bullish price action that is coming while the market is in a risk-off mood. It may be an indication that all the bad news is priced into these stocks and that the sector could have major outperformance when the broader market's risk-off period ends.