Materials Sector Trading Strategy | Backtesting Results

The material sector is considered the primary producer in the supply chain because the companies here provide the raw materials used by other industries. Stocks in this sector tend to do well in a strong economy. However, the sector is not an easy one to trade, quite the contrary. We have backtested many strategies in the sector, but very few work well. In this article, we provide you with one materials sector trading strategy.

What is the S&P Materials sector?

The material sector consists of companies that are engaged in the exploration, extraction, and processing of basic raw materials, which are needed for other sectors to function. This includes the mining companies that provide gold, zinc, and copper, as well as forestry companies that provide wood. Some companies that are not typically associated with materials but are in the sector include container and packaging companies such as the Intertape Polymer Group, a company that produces tape.

Stocks in this sector that are part of the S&P 500 index make up the S&P Materials sector. A capitalization-weighted index of this sector is tracked by various ETFs, such as the Materials Select Sector SPDR Fund (XLB), iShares U.S. Basic Materials ETF, and the Vanguard Materials ETF.

Materials sector trading strategy (XLB strategy)

Let’s go on to backtest a materials sector trading strategy. We backtest the ETF with the ticker code XLB.

We backtest the Monthly Trading Edge of October 2021, a mean reversion strategy. That trading strategy was based on SPY/ES and we bring this up to show that the materials sector is slightly different than the overall market. The equity curve looks like this:

The average gain per trade is 0.38% but as you can see, the road has been pretty volatile with long and deep drawdowns. This is not what you’d like in a trading strategy.

Unfortunately, almost none of our trading strategies we use for the overall market work for XLB and this sector. We backtested a wide range of our strategies we use for other ETFs, but basically, none show any promise.

What are the 5 biggest stocks in the sector?

These are some of the biggest stocks in the S&P 500 Materials sector:

• Linde plc (LIN). Linde plc is an industrial gas and engineering company with operations in the Middle East, Europe, Asia, and North and South America. It offers a wide range of atmospheric gases such as oxygen, argon, and nitrogen; process gases like helium, hydrogen, and carbon dioxide. It serves the Healthcare industry, food and beverages, and aerospace companies amongst others. Its stock price has been performing fairly well with a total market cap of $142.658B as of July 2022.
• The Sherwin-Williams Company (SHW). The Sherwin-Williams Company is a company offering products for architecture and industrial paint contractors. The company’s operation is divided into three segments namely the Americas Group, Performance Coating Group, and Consumer Group. The company has a total market cap of $64.952B.
• Newmont Corporation (NEM). The company engages in the exploration and mining of gold. It also explores for copper, silver, zinc, and lead, and has operations in the United States, Canada, Mexico, Dominican Republic, Peru, Suriname, Argentina, Chile, Australia, and Ghana. As of December 31, 2021, the company had proven and probable gold reserves of 92.8 million ounces and a land position of 62,800 square kilometers. NEM has a market cap of $41.278B as of July 20, 2022.
• Dow Inc. (DOW). This company provides various solutions for packaging, infrastructure, mobility, and consumer applications in the United States, Canada, Europe, and the rest of the world. It operates through Packaging & Specialty Plastics, Industrial Intermediates & Infrastructure, and Performance Materials & Coatings segments. As of July 2022, the company has a market cap of $37.002B.
• Nucor Corporation (NUE). The company manufactures and sells steel and steel products. The company’s Raw Materials segment produces direct reduced iron (DRI) and supplies ferro-alloys. Its Steel Mills segment produces hot-rolled, cold-rolled, and galvanized sheet steel products; plate steel products; wide-flange beams, beam blanks, and H-piling and sheet piling products; and bar steel products. It also engages in steel trading and rebar distribution businesses. The company’s stock has a market cap of $32.499B as of July 20, 2022.

Materials sector trading strategy – ending remarks

Why does the strategy perform much worse in the materials sector than in the overall market?

It’s all about the stocks that constitute the sector. The stocks are different. For example, as of writing, Newmont mining, a gold mining company, is one of the biggest components. Such a stock moves completely differently than the “overall” market. Mean reversion doesn’t work well on such stocks and ETFs.

Do trend-following strategies work better in the materials sector? Unfortunately, we’ve had no luck in making any significant trend following strategy in the sector. Trend following works, but in our opinion not so well in the stock market, and neither in the materials sector.

Overall, it’s pretty difficult to find a profitable materials sector trading strategy.

Why do stocks in the materials sector tend to perform well in a strong economy?

The materials sector consists of companies involved in the exploration, extraction, and processing of basic raw materials. It is considered the primary producer as it provides the essential resources needed by other industries in the supply chain. Stocks in the materials sector thrive in a strong economy due to increased demand for raw materials. As economic activities rise, so does the need for materials, benefiting companies in this sector.

What is the S&P Materials sector, and how is it different from other sectors in the stock market?

The S&P Materials sector includes companies from the materials sector listed in the S&P 500 index. It differs from other sectors by focusing on companies engaged in the exploration, extraction, and processing of raw materials. ETFs like XLB track the performance of the S&P Materials sector. XLB is a capitalization-weighted index that provides investors with exposure to the overall performance of companies within the materials sector.

Can you explain the XLB strategy and the backtesting results mentioned in the article?

Backtesting trading strategies in the materials sector is crucial for evaluating their effectiveness. The XLB strategy is a mean reversion strategy backtested on the Materials Select Sector SPDR Fund. The backtesting results showed volatility with long and deep drawdowns, indicating the challenges of finding a consistently profitable trading strategy in the materials sector.