3 steel stocks to play the manufacturing comeback

Key Points

• The steel industry is setting up to deliver a turnaround if the FED pulls the trigger on its rate cuts initiative, and Goldman's view is right on manufacturing.
• A few names show initiative for a turnaround; the market is willing to go against the 2023 trend that kept these stocks compressed.
• Going against the consensus can pay off big, but keep in mind that it could also bring the most pain.

Every new cycle brings on a new set of opportunities to investor portfolios, and markets provide new waves of shifts between sector performances. Today's market is different from the one you witnessed in 2023, where only the most exciting and high-growth names were the ones getting all the attention.

This year, you should start looking into the boring names out there, especially those in the industrial and manufacturing sectors of the economy. There are, of course, more reasons to back this thesis up. Lucky for you, MarketBeat has done the homework to bring you a list of winning names.

You will soon find you, later in this piece, why names like United States Steel NYSE: X, Nucor NYSE: NUE, and even Steel Dynamics NYSE: STLD could be the most exciting holdings in the coming quarters despite their boring business models. But don’t worry, good investing should be boring.

Clock is ticking

There are a few hidden trends that could push these boring sectors higher in their relative performance to the broader S&P 500 index, and this time, it is the FED itself that comes to sponsor such a move; even one of Wall Street’s biggest names comes to help the push.

You may have heard the rumors that the FED will be cutting interest rates this year, proposing up to six rate cuts. Now, understanding the market mechanics that could turn out if this happens is critical to making money in a situation like this one.

Look, if the FED cuts rates, it is likely that the dollar index will come down (after all, interest rates determine the value of money). A lower dollar hurts some stocks but also helps others; in this case, a lower dollar can make American exports (namely steel) more attractive to foreign nations.

This would essentially help virtually all stocks in the economy's manufacturing sector, which is why analysts at The Goldman Sachs Group NYSE: GS have mentioned that they expect a manufacturing breakout this year in their 2024 macro outlook report.

Now, you must be careful in betting against the consensus because it can bring the most pain to your portfolio and the most potential upside if you get the direction right. Taking a look at the steel stocks can help you understand what the market is expecting in the coming months.

Going shopping?

You will notice a few that stand out in this basket of names according to the market’s language. To translate, you must be aware of the forward price-to-earnings ratio, which is the market’s way of valuing how much it will pay today for tomorrow’s expected earnings.

Because some analysts may still be stuck to their 2023 views, all earnings expectations for U.S. Steel, Nucor, and Steel Dynamics reflect a contraction for the next twelve months. This may change once the realization of a manufacturing breakout sets in.

Understand that this is precisely what you are looking for. If you believe in the bullish case for manufacturing and steel demand, you could afford to take on this view with these stocks. But how does the market feel about them?

Taken as an average, the steel stocks trade at an 8.2x forward P/E multiple, which becomes the benchmark valuation against which you can compare the individual stocks you consider. You will now see the turning sentiment in the space.

United States Steel brings the most significant valuation since its 15.4x forward P/E would place it at an 88.0% premium to the rest of the peer group. It is important to remember the saying, “It must be expensive for a reason.” Knowing what you know now, the reason is more a logical tactic rather than wishful thinking.

Nucor comes in second with its 63.6% premium to the group through its 13.4x forward P/E multiple. Last but not least, Steel Dynamics comes at a 30.6% premium in its 10.7x valuation. Now that we are going through earnings season, Steel Dynamics leads the pack to kick off the potential pivot into a positive outlook from management.

Remember, analysts expect earnings contractions for this whole group in the coming twelve months. But, the market is willing to overpay for these stocks relative to the rest of the sector, and there must be a reason why.

Suppose the FED pulls the trigger on its cuts, and Goldman’s view is proven right. In that case, the market’s pricing system will show you why it paid a premium for these potential winners. Will you?