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The fundamental outlook for the materials sector is looking dimmer. Exchange traded funds tracking this area of the market have not been able to dodge a downgraded rating from S&P Capital IQ, as the sector is moved to Underweight from Marketweight.

According to S&P Capital IQ Global Equity Strategist Alec Young, the sector faces difficult prospects for P/E expansion as demand remains questionable amid weakening economic growth in Europe and the BRIC regions, reports Todd Rosenbluth in a recent note.

The Materials Select Sector SPDR ETF (XLB) is the largest materials sector ETF, and has a heavyweighting to the chemicals sub-industry. The ETF did score a favorable ranking for quality of holdings. This fund also weights to the metals and mining industry, which can help divert some of the risks associated directly with the materials sector.

On the downside, S&P notes that chemicals producers could face increased risks if global growth continues to wane because the firms are highly exposed to international demand trends.

"For chemicals, the largest Materials sector industry group, representing 54% of market capitalization in the S&P 500 Materials sector as of June 22, the team has a positive fundamental outlook due to potential for higher pricing as long as economic growth worldwide continues to look sufficient," S&P Capital IQ said in a research note.

Other materials sector ETFs that have received Underweight ratings by S&P Capital are the First Trust Materials AlphaDEX Fund (FXZ) and the Guggenheim S&P 500 Equal-Weight Materials ETF (RTM).

As the sovereign debt crisis in Europe continues to dominate the news, the outlook for continued growth in emerging economies is bleak. This will drag on the materials sector for the time being, as growth is at a snail's pace.

Materials Select Sector SPDR ETF
(Click to enlarge)

Tisha Guerrero contributed to this article.

Source: S&P Downgrades Materials Sector, ETFs