Seeking Alpha
Long/short equity, growth, medium-term horizon, registered investment advisor
Profile| Send Message|
( followers)  

The respite in Washington is likely to turn hostile again ahead of January's budget debate. As a result, investors may find volatility climb between now and year end. If history is your guide, buying any weakness in November should prove profit friendly.

Markets tend to move higher through January

Over the past decade, major market ETFs typically finish the three months ending January higher than they begin November. The S&P 500 ETF has gained in 8 of the past 10 years, producing an average and median return of 2.60% and 5.24%, respectively. Mid cap (MDY) and small cap (IWM) stocks, as measured by their ETFs, have performed even better, returning a median 7.2% and 7.27% during the period, respectively.

Source: Seasonal Investor Database

(click to enlarge)

Looking deeper, one of the best sectors through January is basic materials. The iShares U.S. Basic Materials ETF (IYM) has finished the period higher in 8 of the past 10 years, producing an average and median return of 4.46% and 6.93%, respectively. That outpaces the broader S&P 500.

(click to enlarge)

3 steel and Iron stocks with catalysts

Within the basic materials sector, one of the best industries for seasonal upside is steel and iron. That basket offers three stocks that have gained ground in 9 of the past 10 three month periods ending January.

1. Cliffs Natural Resources (CLF)

Cliffs' shares have suffered as an anemic economic recovery and capacity built during the 2000's heyday weakened demand for iron ore pellets used to fuel steel furnaces. As a result, shares fell from a peak near $100 to a low of $16 this past summer. Despite the drop, Cliffs' share price has marched higher in each of the past 2 years during the period ending January. This year may offer similar upside, particularly as China's economy is showing early signs it may be improving. The country reported output at China's factories increased 10.2% in September, retail sales climbed 13.3% and fixed asset investment improved 20.2% from a year ago. And, GDP grew 7.8% in the third quarter, faster than the 7.5% rate in Q2. The pickup helped support a rebound in global iron ore prices, which were up 17% year-over-year in Q3 to $133 per ton. Importantly, cost rationalization during the past two years allowed Cliffs to significantly boost earnings power. Cost of Goods sold dropped to 11% in the quarter, leading to a 194% increase in operating income. That translated to EPS of $0.66 versus 0.59 last year. Over the past 10 years, Cliffs has traded higher in the three months ending January 9 times, producing an average and median return of 23.84% and 21.1%, respectively.

More reading: Cliffs Natural Resources' Q3 Earnings Transcript

2. Nucor Steel (NUE)

Overall, steel demand remains tepid in keeping with the anemic U.S. economy. But, expectations for construction spending growth provide upside opportunity for Nucor. If so, demand from building would complement higher demand from other important markets, such as automotive. And, while energy costs can account for up to 40% of total industry costs, Nucor's relationship with Encana offers a 20 year supply of natural gas. That natural gas offers Nucor low cost production at its DRI (direct reduced iron) plants, providing margin opportunity as Nucor's newest Louisiana DRI plant comes on line at year end. Nucor's energy costs fell $2 per ton in 2012 from 2011 and despite steel prices hitting multi year lows this past summer, Nucor still produced net earnings of $0.27 per share in Q2; resulting in first half earnings per share of $0.53. That first half strength continued in Q3, with Nucor reporting EPS of $0.46 per share, well above the $0.35 it earned a year ago. During the third quarter, Nucor shipped 7% more product to outside customers than last year, as utilization climbed to 78% from 73% in Q2. That suggests any increase in prices could provide earnings tailwinds into 2014. Over the past 10 years, shares in Nucor have climbed 9 times from November through January, generating an average and median return of 13.66% and 14.81%, respectively.

More reading: Nucor's Q3 Earnings Transcript

3. Olympic Steel (ZEUS)

Like Nucor, Olympic Steel has faced headwinds tied to a sluggish U.S. economy. However, Olympic Steel's focus not only on products for industrial and farm machinery, appliances and auto but also on higher margin value added processing, offers opportunity. Olympic's flat rolled products benefit from improving auto and aerospace production. And, the company's 2011 acquisition of Chicago Tube and Iron gives it exposure to rising furniture demand tied to new construction. A broadening of its product and service offerings to include higher margin products helped Q2 gross margins climb to 20.7% from 19.5% a year ago. Olympic is also improving its balance sheet, reducing debt by $34 million this year, and restructuring operations in a move to shave $4 million in expenses. If auto and appliance sales continue higher into year end and construction activity picks up in 2014, investors may benefit from picking up shares in November. Shares in Olympic have moved higher over the coming three months 9 times, returning an average and median 24.31% and 27.97%, respectively.

More reading: Olympic Steel's Q2 Earnings Transcript

Source: Seasonal Investor Database

(click to enlarge)

While seasonality isn't the only consideration in buying or selling shares, knowing the seasonal ebb and flow of particular sectors and industries provides a solid starting point for identifying catalysts likely to move names higher or lower. In the case of Cliffs Natural Resources, Nucor and Olympic Steel, rebounding steel demand and potential price upside offers plenty of earnings friendly leverage given the companies cost cutting efforts.

Source: 3 Steel Stocks You Can Buy In November