China’s stimulus and interest rate cuts are great news for this Vanguard ETF, which just hit an all-time high and could have more room to run

China has rolled out a stimulus package that includes lower reserve requirements for banks, lower interest rates, measures to encourage share buybacks, help for home buyers and more.

Chinese stocks and exchange-traded funds (ETFs) — many of them underperformed S&P 500 by a wide margin in recent years — rose in response to the news. But so did he Vanguard Materials ETF (WOW -0.40%)which reached a new daily high on Friday.

Here’s a primer on the ETF and why it might be worth buying now.

Image source: Getty Images.

Distribution supporting economic growth

Top players in the materials sector are companies such as Linde, Sherwin-Williamsand ecolab These companies are big, but they’re just not on the same level as giants in sectors like technology, finance or healthcare. The sector also contains many mid-cap and small-cap companies. A company like Louisiana-Pacific it may not flash on most investors’ radars. But the building products and equipment company is an industry leader and has seen its market cap grow multiple times over the past decade.

Among the 11 stock market sectors, the materials sector has the smallest share in the S&P 500, with only 2.2%. But don’t let its small influence on the S&P 500 distract you from the sector’s importance to global economic growth.

Despite its lack of glitz and glam, the materials sector acts as the foot and shovel of economic growth. Includes chemical companies; miners for steel, copper, silver and gold; packaging, paper and plastic companies; manufacturers of construction materials; fertilizer manufacturers; and more.

Like other cyclical sectors, materials are highly dependent on commodity prices. Oversupply can lead to lower prices and weaker margins. But higher demand can help justify increases in supply and capital investment.

Higher interest rates can discourage capital investment and slow economic growth, weakening global demand for materials. So the Federal Reserve’s decision to cut interest rates and China’s stimulus package are potentially great news for the sector — especially given China’s industrial economy.

ETFs have advantages for commodity-dependent sectors

The Vanguard Materials ETF has an expense ratio of just 0.1% — or $1 for every $1,000 invested. It also has a minimum investment of $1, making it a convenient way to diversify without committing much capital. The ETF has a price-to-earnings ratio of just 16.6 and a yield of 1.6% — which is a considerably lower valuation than the S&P 500 and a slightly higher yield.

There are certain market sectors where ETFs can be particularly effective tools to achieve diversification, and materials is one of them. The Vanguard Materials ETF is a simple way to invest in greater demand for the chemicals and commodities that power the modern economy. If you do not closely follow commodity prices and the materials sector, the competitive advantages of e.g. Dow Inc. compared to LyondellBasell it may not be obvious. So the fund’s 100+ holdings are a good choice for investors who are interested in overall economic growth and higher consumption — not just one industry like copper or chemicals.

In this sense, the materials sector is similar to the utilities sector, where the leading players are located in specific geographic regions. Investing in Vanguard Utility ETF it provides exposure to electric, water and gas utilities across multiple geographies, rather than betting on just a few players.

In conclusion, ETFs can be excellent tools for investing in commodity-focused sectors such as materials, utilities or energy.

A worthwhile ETF for risk-tolerant investors

Like any sector, some materials companies stand out as particularly good buys. However, most investors may be better suited with an ETF to provide exposure to multiple industries rather than just one sector.

The low cost profile and minimum investment requirements for the Vanguard Materials ETF make it the perfect fund for investors to consider if they are optimistic that lower interest rates will help accelerate growth while allowing economic powerhouses like the US and China to avoid recessions.

That said, it’s worth understanding that material stocks can be volatile during times of great uncertainty or economic slowdowns. Over the past five years, the Vanguard Materials ETF’s maximum drawdown was 41.1%, which is how far the ETF has fallen from its high. The peak drawdown over the last three years was 25.5% — which doesn’t even include pandemic-induced selling.

In conclusion, you should only consider the Vanguard Materials ETF if you are comfortable with the volatile nature of the sector.