BCA: The resources down cycle is still in the early days

Global materials equities are collapsing. The negative feedback loop of rising supplies, demand deficiency, price liquidation/deflation leading to declining profitability and investment, signals that the down-cycle is still in the early days. However, before getting overly bearish on the global materials sector, does it still make sense to avoid this heavily exposed commodity sector given the almost uninterrupted share price freefall since the 2011 relative performance peak? The short answer is yes, owing to ailing commodity prices, decelerating growth in China, the global deflationary impulse, a rising U.S. dollar and waning industry operating metrics. Over the past four decades, global materials relative share prices and commodity inflation have been joined at the hip (see Chart). Despite plummeting relative performance, materials stocks have only corrected to the long-term trend line. Not only are deflating commodity prices signaling additional pain ahead, but if history rhymes, it typically takes an undershoot in relative share prices to at least one standard deviation below trend before a trough is reached. Thus, there is ample downside left in relative performance if commodity prices stay weak. (VIEW LINK)