While chemical makers should gain from strength in the automotive industry, recovery in the construction space, strategic growth measures and investment on capacity expansion, the industry is still reeling under many challenges. There are a few reasons to be careful in the chemical industry space in the near term, which we have outlined below:

China Slowdown Casts a Dark Shadow

Economic cooling in China -- a major market for chemicals -- remains a key concern over the near term. A downturn in the country's housing market, persistent credit crunch, overcapacity, a flagging export sector and weak infrastructure investment are hurting the world’s second-largest economy.

China’s export sector, which had been a significant contributor to its economic growth in the past, is witnessing a slowdown. Exports slumped 8.3% in Jul 2015, hurt by lower demand across major markets and a strong yuan. The country’s manufacturing sector also remains sluggish. The final Caixin/Markit China Manufacturing Purchasing Managers' Index (PMI) fell to 47.8 in Jul 2015 (from 49.4 in June), the lowest level in two years, indicating subdued demand. A reading less than 50 indicates contraction in manufacturing activity.

China’s GDP rose 7% in second-quarter 2015, matching the growth level achieved in the previous quarter. While the growth number was better than expected, it still represents the weakest pace in the last 6 years. The country’s economy is expected to slow this year on a year over year basis as the official GDP growth target for 2015 has been pegged at 7%. As such, a sluggish Chinese economy may weigh on demand for chemicals in this significant market.

Eurozone Continues to Sputter

The European economy is still not out of the woods, as evident from the paltry Eurozone GDP growth of 0.3% in the second quarter of 2015, a contraction from a 0.4% gain in the first. While both Germany and Italy raked in lower-than-expected growth, France witnessed complete stagnation in the quarter.

Sluggishness in some of Europe’s major economies continues to deter recovery of the chemical industry in that region. Western Europe continues to pose challenges on chemical stocks due to weak demand, thus remaining a source of near-term uncertainty. Weak investments and high energy costs remain as overhangs on the European chemical industry.

Headwinds from Lower Oil Prices

The sharp decline in crude oil prices over the past year has put several industries on thin ice, and the chemical industry is no exception. West Texas Intermediate crude oil recently sunk to a six-and-a-half year low on concerns over the health of China’s economy, a stronger greenback and surging crude oil production in an already oversupplied market. The absence of a production cut by oil cartel OPEC coupled with booming U.S. production have led to the oversupply, thus hurting oil prices.

U.S. chemical makers are enjoying the fruits of the abundance of low-cost North American feed-stock. Affordable natural gas and ethane (derived from shale gas) has so far offered U.S. producers a compelling cost advantage over their global counterparts who use a more expensive, oil-based feedstock such as naptha. However, the oil price slump has raised concerns regarding the sustainability of this advantage.

On top of that, lower oil prices are hurting demand for chemicals in the energy space, an important end-market. Depressed crude oil price may also keep chemical prices under pressure as they essentially move in tandem with oil prices.

Pricing, Currency Pressure

Commodity pricing remain a concern for many of the U.S. chemical producers. Their ability to pass these costs on to end consumers is not always easy, given the competitive pressures at play. As a result, margins for a number of producers may be under pressure.

In addition, chemical companies generate a major chunk of their revenues outside the U.S., and therefore are exposed to foreign exchange fluctuations. Strengthening of the U.S. dollar against a basket of currencies (especially the euro) created a significant headwind for these companies during first-half 2015 and is expected to continue to be a drag on profits in the second half.

Uncertainty in Fertilizer/Agrichemical Space

Fertilizer and agricultural chemicals makers continue to face challenges from weak pricing, affecting their margins. Weakness in agricultural commodity prices represents a concern for fertilizer companies which may hinder fertilizer use by farmers this year given the adverse effect of lower crop pricing on growers’ incomes.

Weak crop pricing, coupled with anticipated reduction in planted acreage, is expected to weigh on demand for nutrients in the 2015. The U.S. Department of Agriculture (“USDA”) expects planted corn acreage for 2015 to be 88.9 million acres, a decline from 90.6 million acres in 2014, representing the lowest planted acreage since 2010.

Increased production from China is keeping fertilizer prices under pressure. The near-term outlook for the fertilizer space still remains cloudy due to insipid economic growth in certain developing markets.

Moreover, the crop protection market is expected to remain under pressure in second-half 2015, in part, due to a slowdown in Brazil.

Wrapping Up

As you can see, there are a number of reasons to be cautious about the chemical industry despite the recent recovery in the space. We hold a bearish view on Methanex Corp. (MEOH - Analyst Report) and FMC Corp. (FMC - Analyst Report). It would also be a prudent choice to steer clear of certain companies in the fertilizer/agricultural chemicals space that show weak fundamentals. Companies that fit the bill are DuPont (DD - Analyst Report), Potash Corp. (POT - Analyst Report) and Agrium Inc. (AGU - Analyst Report).

But what about investing in the space right now, are there opportunities for short-term investors?

Check out our latest Chemical Industry Outlook here for more on the current state of affairs in this market from an earnings perspective, and how the trend is looking for this important sector.