Trading Outlook: Steel Stocks

While the outlook for the global steel industry as a whole has been steadily improving, the share performance of a number of prominent steel producers has been terrible over the last year. For example, U.S. Steel

has lost 45% over the last 52-weeks and ArcelorMittal

has fallen more than 48%. Among the best performing steel names has been Nucor

which has seen its share price rebound along with the broader market in 2012. Nevertheless, NUE shares are still down 7.38% over the last year. Other prominent names include AK Steel

and Steel Dynamics

. Both of these stocks remain under pressure, however, as AKS shares have lost more than 50% over the last 52-weeks and STLD is down nearly 23% during the same time period. The performance of these stocks comes despite the fact that world crude steel production hit another all-time record in 2011 with 1,527 million tons being produced for the year. The emergence of China has helped to spur demand for steel after a deep fall off in the wake of the global financial crisis. Not only is China the largest steel consumer, but it is also the largest producer by a wide margin, generating almost half of the world's output at 46% and growing 8.9% year over year. This compares to the United States which generated just 6% of global output in 2011 and was growing at a rate of 7.1%. Given the shifting global output and demand dynamics in the steel industry, the market remains significantly fragmented and highly competitive. In addition, steel stocks are very cyclical and some key markets remain under pressure. In particular, the industry is sensitive to demand from global automakers such as General Motors

, Ford Motor Company

and Toyota

. Unsurprisingly, share price trends in these names reflect some of the weakness in prominent steel stocks. For example, Ford shares have lost more than 17% over the last year and GM has lost more than 21%. Taken on balance, however, the automaker segment is considerably stronger than the other major steel market which is construction. Coming out of the 2008 recession, the construction industry, and the housing market in particular, has failed to ramp back up to pre-crisis levels and considerable slack remains. This is witnessed by housing starts that continue to remain near historically low levels. While the current construction outlook remains uncertain, increased optimism and activity will be reflected in steel stocks. Given the depressed levels of many prominent names, these stocks could produce significant gains in 2012 if the lingering headwinds in the construction sector continue to show signs of abating. While uncertainty remains the primary theme, steel companies themselves are putting a positive spin on their outlook for 2012. The industry anticipates that volumes will improve in 2012 on recovering demand and a stronger global economy. Furthermore, operating results are expected to show a sharp improvement versus 2011 driven by higher selling prices and shipment volumes. The positive outlook, however, should be tempered by the knowledge that any kind of weakness or increased uncertainty in the global economy will have an immediate effect on the sector. In particular, fears over a slowing Chinese economy could be devastating for steel producers. Investors also should be aware of other headwinds such as persistently high raw material costs which steel producers have a difficult time passing on to customers amid a tepid demand backdrop. Furthermore, the steel industry continues to suffer from overcapacity, particularly in China. As a result, the world market has been flooded with cheap steel and this development has been a burden for U.S. producers. Despite the risks, however, the steel sector is very interesting given its sharp under-performance. As a result, buying steel stocks which are trading at relatively depressed levels may be one of the best ways to express an aggressively bullish thesis on the global economy. Because end markets for the industry are still under pressure despite a clear improvement in worldwide economic conditions, the sector has lagged most other areas of the market. If sentiment and economic growth were to continue to ramp sharply in the coming years, steel stocks could be among the best performers given current valuations.