In This Year's S&P 500, Materials Are the Worst Performer. What 2025 Holds for This Beaten-down Sector?

U.S. stocks are closing out 2024 with impressive gains, but not all sectors are sharing in the success. The materials sector, one of the 11 segments within the large-cap S&P 500 index, has emerged as the year’s worst performer, based on data from FactSet. Despite the S&P 500 climbing 24% in 2024, the materials sector has declined 0.6% year-to-date, marking the widest performance gap since 1998, according to Dow Jones Market Data.

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In stark contrast, the communication-services and information-technology sectors have been standout performers, with gains of 40% and 37.5%, respectively. These figures underscore the challenges faced by materials stocks, which are often categorized as cyclical investments. Their performance is closely tied to the state of the global economy, as demand for resources like metals, chemicals, and construction materials typically weakens during economic slowdowns. Commodity price fluctuations also significantly impact the profitability of companies in this sector.

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This year, several factors have weighed heavily on the materials sector. Concerns about the strength of the U.S. economy, a slowing Chinese economy, and persistently high global interest rates have all contributed to its struggles, explained Ashley Fernandes, a portfolio manager and natural-resources sector leader at Fidelity Investments.

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The U.S. Federal Reserve maintained interest rates at a 23-year high for most of 2024, only beginning to ease its monetary policy in September. While fears of a U.S. recession have subsided somewhat, they remain a lingering concern. Meanwhile, the slowdown in China, the world’s largest industrial economy, has been another major headwind for the materials sector. Despite this, Chinese leaders have introduced stimulus measures aimed at revitalizing their economy, offering some hope for future growth.

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From a technical standpoint, the materials sector appears significantly oversold. According to Jonathan Krinsky, chief market technician at BTIG, the Materials Select Sector SPDR Fund (XLB) recently registered a relative strength index (RSI) of 17, the lowest level since 2018. The RSI is a widely used indicator to assess the speed and magnitude of price movements, with readings below 30 generally considered to signal an oversold condition.

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Krinsky pointed out that since the inception of XLB in 1998, there have only been 14 other instances when its RSI dropped below 20. Historically, this has often been followed by a rebound, with an average gain of 5.54% over the next 15 days. Based on this pattern, Krinsky suggests there may be tactical opportunities for investors to capitalize on a potential recovery in materials stocks.

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Historically, the S&P 500’s materials sector has not experienced consecutive years of decline since 1990, making 2025 an intriguing year to watch. Last year, the sector gained over 10% before slipping into negative territory this year. On average, its returns following a down year have been 20.43%, with only one instance of a gain below 10% during this period.

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Looking ahead to 2025, Fernandes predicts that the materials sector will continue to mirror the performance of the U.S. and global economies. However, with interest rates starting to decline in major economies and China rolling out additional stimulus measures, there is potential for a new growth cycle. These factors could drive demand for materials and bolster stock performance in this cyclical sector. In a client note, Fernandes stated that global monetary easing and a recovering Chinese economy could support growth in materials markets next year.

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Nevertheless, uncertainty surrounding President-elect Donald Trump’s tariff policies on Chinese imports remains a potential obstacle for the sector. Fernandes acknowledged the unpredictability of public policy outcomes, cautioning against making definitive forecasts.

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However, Talley Leger, chief market strategist at the Wealth Consulting Group, suggested that Trump’s tariff threats might be more of a negotiating tactic than an economic detriment. Leger argued that raw materials play a fundamental role in Trump’s broader goal of revitalizing U.S. manufacturing and competitiveness, making the sector an interesting long-term opportunity.

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Investors may need to be selective in their approach to the materials sector. For example, the S&P 500’s containers and packaging industry index has gained nearly 18% this year, significantly outperforming the broader materials sector’s 0.6% decline. Similarly, the S&P SmallCap 600 Materials index has risen 0.3% in 2024, slightly edging out the large-cap materials sector. These pockets of strength highlight opportunities for investors to capitalize on specific subsectors within the broader materials industry.

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In summary, while the materials sector has faced significant challenges in 2024, there are reasons for cautious optimism heading into 2025. A combination of global monetary easing, potential economic recovery in China, and selective opportunities within the sector could pave the way for improved performance in the year ahead. However, lingering uncertainties, such as tariff policies and broader economic conditions, underscore the importance of a measured and strategic investment approach.

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