Worst stocks to reverse with commodity profits rising 18%

Riskier Securities

China’s rise to the world’s second-largest economy was fueled by gross domestic product growing an average 9.3% a year during the decade through 2010, data compiled by Bloomberg show. U.S. commodity stocks rallied 82% and the S&P GSCI gauge of 24 raw materials more than doubled. In those 10 years, the S&P 500 declined 4.7%.

A rally in commodity stocks shows investors are favoring companies with profits most sensitive to changes in the economy and riskier securities, according to Hayes Miller, who helps oversee about $57 billion as the Boston-based head of multi- asset allocation in North America at Baring Asset Management Inc. That’s a sign the bull market will continue, he said.

“This begins a segment where the market can grind higher for quite some time,” Miller said by phone on Oct. 3. “It’s about growth. It’s about shift from yield.”

Quarterly Return

The gauge of raw-material producers gained 9.7% in the third quarter as Chinese manufacturing and exports climbed, compared with a 4.7% rise in the S&P 500. Utilities and telephone companies, which offer shareholders the highest dividend payments, posted the only declines among the S&P 500 industries last quarter.

Investors are starting to price in faster earnings growth for the industry in 2014. While income at the S&P 500 group rose 0.7% in the third quarter, the pace will accelerate to 16% in the last three months of the year, according to estimates tracked by Bloomberg. Analyst predictions for 2014 earnings growth of 18% would represent the biggest increase since 2011.

Valuations for mining and metals companies are too expensive and the shares have further to fall should China’s economy weaken, according to Zach Jonson, the director of fund management at ICON Advisers Inc. Allegheny Technologies Inc., a Pittsburgh-based steel producer, and Alcoa trade at a price- earnings ratio above 40, the highest among S&P 500 commodity shares, data compiled by Bloomberg show.

Valuation Shift

“I’m still not ready to flip the switch to become extremely bullish,” Jonson said in a phone interview from Greenwood Village, Colorado. His firm manages about $1.5 billion, including the ICON Materials Fund that has beaten 92% of its peers in the past year. “We’re just not seeing the valuation shift like we’d like to.”

The measure of S&P 500 raw-materials companies is valued at 18.8 times reported operating earnings, the third-highest level among the 10 main industries, data compiled by Bloomberg show. The price-earnings ratio for the group is up 16% this year, compared with a 15% increase for the S&P 500.

Goldman Sachs Group Inc. forecast in September that its favored gauge, the S&P GSCI Enhanced Commodity Index, will fall 2% in 12 months, with declines in energy, precious metals, agriculture and livestock. Barclays Plc says production of aluminum, copper, nickel and zinc will exceed demand next year and the London-based International Grains Council expects expanding global production of wheat, corn, rice and soybeans.

Monsanto Earnings

Monsanto Co., the world’s largest seed supplier and the top-weighted company in the index of commodity companies, last week estimated annual profit that trailed analysts’ estimates. Corn has fallen 42% in the past year amid forecasts for a record crop in the U.S., the world’s biggest grower. Modified corn seed is Monsanto’s largest business.

Howard Ward, the chief investment officer for growth equity at Gamco Investors Inc., said he’s bullish on companies that produce fertilizers and metals used to build planes and cars. The Rye, New York-based firm owns shares of Wilmington, Delaware-based DuPont, the biggest U.S. chemical maker.

“Not all materials stocks are created equal,” Ward said in a phone interview on Oct. 3. “There are other materials sector companies with brighter prospects due to exposure to agriculture or an upturn in U.S. manufacturing and housing construction.”

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