Tapping the Power of Energy and Utilities

Stocks in those sectors -- including Edison International and Exxon Mobil -- are among S&P's favorites, says David Braverman

The places to be in the stock market these days are energy and utilities, with a sprinkling of financials and consumer cyclicals. So says David J. Braverman, senior investment officer for Standard & Poor's Equity Investor Services. Braverman is cautiously optimistic -- cautious because corporate earnings are still disappointing and long-term interest rates have crept up a bit despite Federal Reserve cuts on the short-term side.

Braverman predicts that the S&P 500 could end the year up 10%, although that is another cautious forecast. In the meantime, he looks for something of a rise in the Nasdaq, sparked by a bounce in semiconductor stocks.

In discussing the strong buy names on S&P's STARS (Stock Appreciation Ranking System) list, Braverman cited, among others, Allstate, Alltel, Edison International, Exxon Mobil, and IBM.

These were among the market views Braverman expressed in a chat presented Apr. 24 by BusinessWeek Online and S&P on America Online. He was replying to questions from the audience and from Jack Dierdorff of BW Online. Edited excerpts from the chat follow -- a full transcript is available on AOL at keyword: BW Talk.

Q: David, the market has looked pretty promising recently, and today started off nicely -- but fell off. Can we be optimistic in the face of continuing unpleasant economic news?

A: We can be cautiously optimistic in light of the recent Fed rate cuts, but two things are troubling here. The first is that, although earnings are coming in in most cases in line with expectations, they are still disappointing when compared with a year ago. The second problem is that although the Fed has been cutting short-term rates, long-term rates have stopped heading lower and have backed up a bit.

Q: Do you think the Fed's actions can turn the economy around?

A: Ultimately, yes. I think there is going to be a great deal of economic stimulus developing from the interest-rate cuts, combined with likely tax relief later in the year.

Q: Given that forecast, what stocks and sectors look best to S&P now?


We would be looking still at utilities and energy stocks right now. We would also be taking a long, hard look at some of the financials and possibly some of the consumer cyclicals.

Q: Before we proceed, explain to us the S&P STARS list -- STARS, of course, stands for Stock Appreciation Ranking System.

A: Our STARS system is on a 1-STAR through 5-STAR scale, with 5 STARS representing our recommendation for a strong buy and 1 STAR representing a sell recommendation. These are with a 6- to 12-month time horizon.

Q: In your pet sectors, what are your favorite names?


Right now, my 10 favorite stocks, all ranked 5 STARS, are Allstate (ALL ), Alltel (AT ), BJ's Wholesale Club (BJ ), BJ Services (BJS ), Cytyc (CYTC ), Edison International (EIX ), Home Depot (HD ), IBM (IBM ), Rehab Care (RHB ), and Tyco International (TYC ).

Q: Has the California mess affected your outlook for utilities?


To some extent, that has occurred. It's becoming increasingly clear that new generating capacity is going to have to be built and electric bills are going to continue to have some upward pressure. This, combined with lower interest rates, makes utilities more compelling than they had been several years ago. In fact, we think that Edison International, the electric utility in Southern California, has bottomed and is now a good speculative opportunity.

Q: What's your prediction on how long we have to wait for a tech turnaround?


It depends on what you define as a complete tech turnaround. I think, for example, that it will be several years before we see 5000 on the Nasdaq again. But, on the other hand, we think that technology ought to be a portion of most equity portfolios. It should probably be in the 15% to 20% range. Here are some more of our 5-STARS tech names. Those include Adobe Systems (ADBE ), Applied Materials (AMAT ), Atmel (ATML ), KLA Tencor (KLAC ), Symantec (SYMC ), and Xilinx (XLNX ).

Q: What do you like in energy?


Well, our favorite energy stock right now is Exxon Mobil (XOM ). Other names that we like include BJ Services (BJS ), El Paso Energy (EPG ), Devon Energy (DVN ), and Global Marine (GLM ). These names give some balance between the upstream and downstream portion of the industry, and we think oil prices will probably remain high for some time. They are all 5 STARS.

Q: What do you think of this portfolio -- SFE (Safeguard Scientifics), NOK (Nokia), ORCL (Oracle), JDSU (JDS Uniphase), NUFO (New Focus), and ADIC (Advanced Digital Information)?

A: Before I talk about each stock individually, my general comment is that you're just about 100% in technology. I would not recommend [being only in] a single sector. Specifically, we're recommending accumulate on Nokia, and we also like Oracle, but we've thrown in the towel for the time being on JDS Uniphase, and we have a hold recommendation on it currently...but we think ultimately there is good recovery potential.

Q: What is your outlook for the drug group -- specifically MRK (Merck)?

A: Long-term demographics for the drug companies remain strong. However, it looks like the large drug companies are no longer in a leadership role in the marketplace. We currently have hold recommendations on most of the large pharmaceuticals, including Merck, Pfizer (PFE ), and Bristol-Myers Squibb (BMY ). Probably our favorite drug stock at the moment is Johnson & Johnson (JNJ ), which holds a 4-STAR (accumulate) ranking.

Q: What is your opinion of the biotech sector?

A: We currently like the biotech sector for the long term, and we would probably stick with some of the larger firms in the industry. We currently have 4-STAR rankings on Genentech (DNA ) and Amgen (AMGN ).

Q: Can the low interest rates cover all the bad debt from credit cards and other uncollectibles? I am asking about the financials, like C (Citigroup).


You ask a good question, because as the economy weakens, the conventional wisdom is that there will be more bad credit-card debt. So far, though, this is not something that has happened to any great extent in this cycle. And most of the credit-card issuers continue to report that nonperforming loans remain at fairly manageable levels. But obviously, this is the concern of the Fed and one of the reasons that they have been aggressively cutting interest rates. The idea is that as interest rates fall, people have the breathing room to refinance their mortgages and continue to keep their debts current. We think that all of this is going to work out, and to make a long story short, Citigroup is still a buy.

Q: Have any stocks recently been downgraded by S&P?

A: We are continually changing our opinion on many stocks. Just today, for example, we downgraded AT&T Wireless (AWE ) to neutral, and we downgraded Kimberly-Clark (KMB ) from 5 STARS to 4 STARS because the outlook is a little less optimistic. We haven't downgraded any stocks to sell or avoid since Apr. 19, when we cut our opinion on Sabre Holdings (TSG ), in part because of the economic slowdown.

Q: Many analysts think small- and mid-cap stocks will do better than the large caps in the near term. Do you agree? And is any of this reflected in the S&P indexes?

A: Yes, I would agree with that. Valuations in the small- and mid-cap areas are still better than in large caps, despite the outperformance of mid-cap and small-cap stocks during 2000. Yes, the MidCap 400 index did substantially better than the S&P 500 did during 2000.

Q: While we're on S&P indexes, do you have any predictions for yearend 2001 yet?

A: I'm cautiously optimistic that we can go up perhaps 10% from current levels, which would bring us to around 1350 on the S&P 500.

Q: Do you think the Nasdaq is headed to test its recent bottom?


That's certainly possible. But I think the test will be successful, and we will quickly resume a rise to above 2200 on the Nasdaq.

Q: Just where is the leadership going to come from for the Nasdaq to get over 2200?

A: It will probably come from the technology sector, but more specifically, our view is that there will be a bounce in semiconductor stocks.

Q: Your view on AOL (AOL Time Warner)?


Last week, we upgraded AOL to accumulate after better-than-expected first-quarter results. It will be interesting to watch how AOL does in an economic downturn, but people don't seem to realize that the company has [well over 20 million] subscriptions now and is a formidable economic force. So we think AOL is a nice position to have in most portfolios.

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