If high oil prices are "transitory" and the economy is poised to rebound, as the
claims, does that mean investors should dump energy stocks and load up on cyclicals?
Analysts at Merrill Lynch, Smith Barney, Banc of America Securities and Bear Stearns say no.
Since the start of the year, the Standard & Poor's energy sector has climbed about 11%, as a confluence of events has pushed the price of oil up to record levels. Meanwhile, the basic materials sector has fallen 5%, technology has declined about 14%, and consumer discretionary stocks are off by 7% amid concerns that the economy might be slowing down.
The Fed, and its chairman, Alan Greenspan, hinted recently that these trends could reverse, noting that the jump in energy prices has been temporary and that the economy is "poised to resume a stronger pace of expansion."
Yet analysts, who have correctly predicted the market's direction this year, continue to recommend oil stocks, as well as companies that typically do well in a weaker economic environment.
Smith Barney strategist Tobias Levkovich thinks investors should be looking at stocks like
( PBG), because the economic outlook is simply too uncertain to be more aggressive.
"If the economy is utterly bad tomorrow morning, people will still shower, brush their teeth and put on deodorant," he said. "People are paying a premium
for consumer staples so they can sleep at night."
While Levkovich concedes that consumer staples stocks are expensive, he said economically sensitive issues are much more at risk of missing analysts' lofty earnings estimates.
Kulicke & Soffa
have all delivered cautious outlooks on the second half of the year, sending their shares down sharply this week.
"The only way you can say
cyclical stocks are cheap is if you know for certain that the forward expectations are correct," he said. "What we've been finding out over the past few weeks is that they aren't."
Bear Stearns strategist Francois Trahan believes the shift toward noncyclical sectors of the market is still in its early stages.
"The outperformance of noncyclical groups year to date is likely just the beginning of a longer-lasting trend, where cyclical sectors will increasingly pass the leadership reins to their noncyclical brethren," he said in a recent note.
Trahan believes the economy has been losing momentum this year "albeit from very elevated levels," and he said gauges of future activity suggest that growth has peaked. Indeed, the Conference Board's index of leading economic indicators declined in June for the first time in more than a year. Cyclicals "do not tend to fare well when economic momentum comes off the boil," he said.
Richard Bernstein, chief quantitative strategist at Merrill Lynch, thinks it's still appropriate for investors to overweight consumer staples stocks, and he recently upgraded his view on utilities, a traditional safe haven.
The S&P utilities sector has outperformed this year, climbing almost 5% while consumer staples are up just fractionally. Bernstein said both groups are heavily shorted in the market and both are under-owned by mutual funds; this makes them attractive from a contrarian standpoint. He likes
Over at Banc of America, analyst Tom McManus is recommending names like
-- hardly stocks that would be the prime beneficiaries of a big upswing in the economy. What's more, McManus still thinks energy firms like
have further to climb.
Six weeks ago, Greenspan dismissed the rise in oil prices as "transitory," and he repeated this claim at the Fed's Open Market Committee meeting on Tuesday. But crude oil prices have continued to shoot up, recently hitting $45.45 a barrel, on concerns about potential supply disruptions from Russia, Venezuela and Iraq.
Levkovich said he remains bullish on energy stocks because valuations still look attractive. But he noted that when oil prices climb too much, demand often cools down and prices naturally retreat. "While we cannot know exactly where this tipping point is, we do think we are nearing it," he said. "Although we are maintaining our overweight stance for now ... we may be entering the seventh or eighth inning in terms of relative stock price gains."
Jim Melcher, president of Balestra Capital, said there are very few stocks that make sense in the current environment, other than oil.
"Wall Street would have you believe that oil prices are going to come down, but over the next five years we're going to find ourselves short of oil," he said. "As far as pumping ability, we're right at the limit."
Melcher said he can't recommend consumer staples right now, because they're too pricey, but he thinks investors can find safety in the health care sector.
Levkovich agrees, saying that many stocks in the group have been "beaten up" and now look inexpensive. He recommends
. Conversely, he remains worried about capital goods stocks such as
and said technology stocks could continue to slide.
"Oil prices are high, we've got terrorism concerns up the yin-yang with the Republican convention, the Olympics and the anniversary of Sept. 11 coming up, and the election is hotly contested," Levkovich said. "How confident are CEOs going to be to accelerate their spending in the next two or three months? It doesn't seem reasonable."