Steel stocks were some of the worst performers in 2015.
That shouldn’t surprise most investors. Companies that produce steel used for building skyscrapers, cars, bridges and power lines are among the greatest “boom and bust” assets in the world. They soar and crash as the global economy fluctuates.
Last year, some of the world’s largest economies including Europe, China and Japan slowed considerably. This slowdown resulted in fewer infrastructure projects … fewer pipelines and drilling rigs being constructed … and fewer ships being built to transport goods.
In fact, China (the largest steel producer) reported its first year-over-year decline in supply in a quarter-century. To put this in perspective, China’s steel output surged more than 12-fold from 1990 to 2014.
Weak demand coupled with excess supply resulted in an outright crash in steel stocks. As you can see below, the sector fell more than 40% in 2015. This compares to just a 1% pullback in the S&P 500 Index over the same time frame.
There’s no sugar-coating it … last year was one of the roughest periods to own steel stocks.
However, there is a fundamental shift taking place right now that’s likely to push the sector much higher this year. And investors stand to make big returns buying steel stocks at current levels.
Let me explain …
Steel stocks suffered from a global economic slowdown. Most countries within the euro zone slowed significantly last year … China’s economy grew at its slowest pace in 25 years … and the U.S. economy — while in better shape than most global economies — is growing below its historical average.
Sure, it looks dire out there — especially if you believe the negative headlines you read every day.
But the last time we saw a global slowdown like this, it turned out to be a huge buying opportunity in steel stocks!
For example, during the 2008-’09 credit crisis, the Market Vectors Steel ETF (SLX) fell sharply.
Back then, most steel stocks traded below 10 times earnings. One year later, the index jumped 140%.
As you can see from the chart, steel stocks have been trending higher …
That’s because inventory levels in China (which accounts for almost half of all steel production) are exceptionally low. This has led sell-side firms like Goldman Sachs (GS) and JPMorgan (JPM)to upgrade the sector recently.
Plus, most global economies are doing everything in their power — including using negative interest rates — to stimulate their economies. China also said it plans to increase infrastructure spending based on their latest “Five Year Plan.” This economic/development plan spans from 2016 to 2020.
In short, the steel industry is undergoing a fundamental shift. There is less supply on the market with much stronger demand expected over the next few years.
This is a recipe for higher prices, thus the reason steel stocks have started trending higher over the past few months.
My favorite name in the sector is Steel Dynamics (STLD). The stock is trading at just 13 times forward earnings. That’s a huge discount to the S&P 500, which is trading at 17 times earnings.
Steel Dynamics also has one of the strongest balance sheets in the industry, pays a solid 2.5% dividend and is expected to grow earnings by more than 60% annually over the next two years.
To put this in perspective, S&P 500 earnings this quarter are expected to decline year-over-year.
I suggest adding some steel stocks to your portfolio. Sure, some names have run higher over the past few months. But there is still much more upside potential in this once left-for-dead sector.
