Will Steel Stocks Bend?

Few markets, including the never-boring precious metals complex, have had a profound turnaround quite like steel stocks. In the early fall of 2014, steel stocks – using the exchange-traded-fund Market Vectors Steel (SLX) as a benchmark – were holding up well. That, however, changed dramatically. By the end of that year, the SLX dropped more than 25% in market value. The pain worsened in 2015, with the steel stocks ETF shedding nearly 41%.

It was only natural investment analysts took a dim view towards the industry. Of primary concern were American steel stocks. Their forward-looking valuation was dimmed considerably by cheap, Chinese steel that exacerbated a global supply glut. Even European producers voiced harsh criticisms towards the Asian giant machinery. The question, of course, was why would anyone pay full retail for steel when China was always on discount?

But then a strange thing happened. Economic data in the U.S. and other parts of the world started to improve. Demand began to pick up, resulting in an extraordinary recovery in steel stocks. The 2016 election cycle focused on the industry as a symbol of American manufacturing might. Donald Trump, though, took the most advantage of the populist appeal, which ultimately secured him victory. In the ensuing Trump rally, steel stocks soared under his promise to make America great again.

The SLX climbed a nearly 38% in in the month following the election before pulling back a bit.

However, in recent weeks, individual steel stocks have demonstrated a sudden lack of enthusiasm. While this could be a natural correction, there are warning signs the sector could give back all of the gains from the Trump rally — and then some. For starters, there’s evidence China has increased its imports of iron ore — which is used to make steel products — to more than they actually consumed. Consequently, the outlook by Credit Suisse analyst for steel stocks has turned negative.

The message is clear: The Trump rally was one of the most remarkable developments in modern American history, but you can’t cheat gravity, which is why investors need to steer clear of steel stocks. With that in mind, here are the two major steel stocks that investors should consider selling.

United States Steel Corporation (X) is the powerhouse name among steel stocks. Employing over 33,000 workers, X wields considerable economic and political leverage.

It was companies like U.S. Steel that helped turn the tide for the real estate mogul turned President-elect. Let’s face it — Trump won Pennsylvania by a very slim margin.

There’s no doubt that steel workers have high expectations from the upcoming administration. The Trump rally has partially rewarded their faith. But since gaining an incredible 59% from election day to the end of 2016, X stock hit a snag. Shares are only up 0.27% to start the new year, trending just barely above its 50-day moving average. Against the high of Dec. 8, X stock has shed a disconcerting 12%.

Is the Trump rally no longer a relevant factor for major steel stocks like X? I don’t want to be alarmist, but I think it’s fair to say the fundamentals aren’t favorable. If indeed China has bitten off more iron ore than they can chew, price deflation is virtually guaranteed. And in such circumstances, the original question asked of steel stocks is more relevant than ever: who is going to pay full retail?

AK Steel Holding Corporation (AKS) is one of the premiere names in steel stocks, employing 8,500 people. Despite its pedigree, AKS has endured one of the most volatile periods in its history. In the summer of 2014, AKS stock briefly traded for over $11 a pop. By January of last year, AKS dipped below the $2-mark. Rightfully, people questioned whether the company was going to meltdown.

Thanks to bullish momentum speculating on an economic recovery, AKS engineered a near-miraculous turnaround. For 2016, the company secured eye-popping profits of over 334% — something more familiar to tech investors or Bitcoin fanatics. Of significant note is that since Nov. 8 of last year, the Trump rally tacked on 60% to the fortunes of AKS.

So why shouldn’t buyers continue to jump in on the company? Isn’t the trend my friend? The latter is a true statement, so long as the trend is holding. But even though 2017 is young, AKS is down 6%. And I don’t think it’s just a matter of lucky investors taking profits off the table. The outlook for steel stocks in general doesn’t look great.

— Steve Smith

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About the Author: Steve Smith