The performance of U.S. companies in the industrials and materials sectors may shed light on inflation-related problems

Lewis Krauskopf

NEW YORK (Reuters) – Business performance in the industrials and materials sectors could provide a picture of how companies in a key part of the U.S. economy are dealing with rising inflation, supply chain bottlenecks and higher commodity prices.

Companies in these sectors – which include logistics and transportation companies, major chemical producers and manufacturers, and suppliers to the aerospace, automotive and construction industries – are expected to post strong results in the third quarter.

But their position in the global economy gives many companies in the industrial and materials sectors insight into the effects of rising production costs, supply chain problems and other problems that are plaguing the United States and other countries as economic reopenings trigger a surge in demand.

Signs that businesses continue to raise costs or expect inflation and logistical problems to continue could reinforce the view that the recent increase in consumer prices will prove more persistent than expected, despite assurances from the Federal Reserve that the recent increase is likely to be temporary.

Supply chain and inflation issues have affected companies across a wide range of sectors, from technology companies to consumer products companies.

Many industrial and materials companies have already reported the challenges they face. Diversified manufacturer 3M at an investor conference last month pointed to higher-than-expected inflation due to cost pressures for resins, wood pulp and labor. Last month, Eaton Corp warned that its third-quarter revenue would be “slightly below” the lower end of its forecast, largely due to its “inability to meet the demand we are receiving.”

Also last month, paints and coatings company Sherwin-Williams lowered its 2021 sales and earnings estimates, citing “increasing raw material availability challenges and inflationary factors.”

“Everyone will feel pain at a different rate,” said Joshua Aguilar, a U.S. multi-industry analyst at Morningstar. “Your short cycle businesses will be the first to feel this, but no one will be immune. Ideally, someone would have pricing leverage to offset that.”

Investors will learn more in the coming days as corporate reports come in, including those from Dow Inc on Thursday and from 3M, General Electric and Caterpillar next week.

Industrials and materials stocks were among the economically sensitive cyclicals that benefited broadly after breakthrough vaccine data last November that raised optimism about the economy’s ability to recover from the coronavirus pandemic.

However, while the energy and financial sectors continue to dominate among such economically sensitive groups, industrial and materials stocks are weighed down by concerns about how the effects of higher prices and supply chain problems will affect their financial results, investors say.

While the overall S&P 500 index has gained 14% since the end of the first quarter, the S&P 500 industrials sector is up about 6% and the materials sector is up about 8%.

“We know this quarter was impacted by margin issues, but will this continue for the next two quarters or will this be a one-quarter event?” said Walter Todd, chief investment officer at Greenwood Capital in South Carolina. “That’s the real unknown at this point and it’s going to impact… how these stocks respond.”

Industrials make up 8% of the total S&P 500 index, while materials make up 2.5%.

Some investors are betting that companies in these sectors will see more benefits, especially if they can weather rising costs, including through great pricing power on their products.

Ryan Cope, portfolio manager at American Century Investments, holds shares of bearing maker Timken Co in the small-cap portfolio he manages.

“Companies that incorporate pricing into their business models will really start to perform significantly better than companies that don’t,” Cope said.

(Reporting by Lewis Krauskopf; Editing by Ira Iosebashvili and Diane Craft)