This Stock Market Sector May Be the Toughest to Predict

If you could only invest in a basket of stocks from one sector in 2022, which sector would it be?

In this clip from "The Rank" on Motley Fool Live, recorded on Jan. 31, Fool.com contributors Jason Hall, Dan Caplinger, and Matthew Frankel, CFP®, discuss one sector they think is difficult to predict, and that could have a challenging 2022.

Matt Frankel: Coming in at No. 11, we all ranked this pretty low. This is the materials sector. Jason, why don't we start with you. This was your 11 out of 11 so I wanted to start with you on this. Why do you rank it so low?

Jason Hall: Honestly, as much as anything it's because it's a really challenging sector to predict. The companies in the materials sector, this is basic materials so you think about like mining and lumber production and so much of those basic materials that the stocks not always but in a lot of cases are like leveraged bets on the commodity price. Again, that's not always the case, but by and large, it really is for a couple of reasons. Because those materials, they'll have hedges to a certain extent, where they'll have a certain amount of their production that's locked in at a price. That gives them a floor. But then their excess production they sell through the market, so if the market's going well, they're gangbusters and if the market's not going well, depending on how much of their output they've already sold, they can go from profitable businesses to money-losing businesses very very quickly. We've seen so much with all of the supply chain stuff, everybody's heard about lumber prices. We've all heard that story. Oil prices now that's in the energy sector. But again, it's the idea of predictability of this stuff. We've seen so much of a run-up in so many commodity prices and it's stabilized some. I just really have a hard time predicting whether this sector is going to be a market outperformer. It could do well. Honestly this could end up over the next few years being a great sector. It's really hard for me to nail down with any level of certainty whether that's going to be the case.

Frankel: Dan, you ranked this one notch above where Jason did. This was your No. 10 out of 11. Why are you so much more bullish on materials than he is? [ laughs]

Dan Caplinger: Just mostly because I think there's as we'll see another sector I think it's not going to I do as well. But I share a lot of what Jason was saying here. I think that some of the most successful stocks in the materials sector have been successful because of some of the supply chain disruptions is sent, commodity price is so much higher, it's leading to really attractive value trap valuations. When you look back at 2021 earnings and multiples to earnings for the stocks, you can tell that even with a decent-sized rally in some of the higher performers in the sector, you still have these earnings multiples that look really low and yet, when you look at the analysis to get a sense of where people are projecting that their earnings are going to look like in 2022 for a lot of the most successful ones, they're pegged to come back down because there's a lot of pessimism about whether those supply chain challenges will remain in place once the supply chains free up, supply gets freed up and then suddenly the price comes crashing down. Then I think at that point some of the bullish investors in that sector are going to say, "This is why those earnings multiples were so good is because earnings are down. Now my earnings multiple is backup, but not because my price went up, it's because my earnings went down and so my denominator went down." It's a classic cyclical thing that a lot of folks who don't follow cyclical sectors as much, it's easy to fall into that trap, but I think that we're setting ourselves up for that kind of environment in 2022.

Frankel: That's fair. Honestly, one of the reasons I ranked this so low is there's so many unanswered questions. Like what you said, the supply chain issues, they can clear up this year, they can clear up in 2024 for all we know. There's just a lot of unanswered questions. There are a lot of other sectors that I think are easier to evaluate right now, which is probably why I ranked it a little bit lower.