Buy Energy, Commodities, Money Managers Say

BOSTON ( TheStreet) -- Middle East turmoil has pushed up oil prices to more than $100 a barrel, making accelerating inflation the greatest threat to the fragile U.S. economic recovery since Europe's debt woes.

Still, professional investors including Robert Pavlik, chief market strategist at Banyan Partners, and Paul Nolte, director of investments at Dearborn Partners, say the economy is resilient enough to withstand higher commodities prices. Improvements in retail sales, the manufacturing industry and the job market have prompted the Federal Reserve to say this week that the economy "continued to expand at a modest to moderate pace."

Investors have been jolted by populist uprisings in the Middle East and North Africa, which have threatened to disrupt oil supplies, causing a spike in prices. Nouriel Roubini, the economist who correctly forecast the financial meltdown almost three years ago, said this week that an escalation of unrest may push prices to as high as $150 a barrel. The benchmark S&P 500 Index of the largest U.S. companies tumbled 1.6% Tuesday as fears rippled through the markets.

Violent protests that led to the ouster of Hosni Mubarak in Egypt have also unsettled Libya, where anti-government protesters are rebelling against Moammar Gadhafi's regime. Those uprisings have sparked similar protests in other Middle Eastern and North African countries, including Bahrain, Saudi Arabia, Yemen, Tunisia, Cote D'Ivoire and even Iran.

Fear and uncertainty over the Mideast crisis has resulted in a so-called flight to quality, with gold prices rising to all-time highs after declines earlier in the year.

Since the Egyptian protests began Jan. 25, the S&P 500 has climbed 1.4%, but after oil prices spiked from $86 a barrel to nearly $100 on Feb. 18, the broad stock-market index has slumped 2.5%. As March 6 marks the two-year anniversary of the market bottom, investors now question whether the bull-market rally that has produced returns of almost 80% is finally over.

Since Feb. 18, recent high-fliers such as Netflix ( NFLX), First Solar ( FSLR) and AIG ( AIG) have been among the worst-performing members of the S&P 500. On the other hand, energy firms like Chesapeake Energy ( CHK), Cabot Oil & Gas ( COG) and Consol Energy ( CNX) have been the biggest winners.

But those rocket stocks aren't the only ones getting punished. Economic barometers such as FedEx ( FDX), ( AMZN), U.S. Steel ( X) and Ford ( F) are each down 7% or more since Feb. 18. The consumer-discretionary sector has also been pummeled, with the Retail HOLDRs ETF ( RTH) dropping 3.5% over that time.

Kevin Mahn, managing director and chief investment officer with Parsippany, N.J.-based Hennion & Walsh, notes that this is around the time when most portfolio managers and advisors reset their asset-allocation strategy for the new year. He advises clients to keep a steady hand.

"They should build a long-term allocation strategy and stick to it outside of any significant macroeconomic events," Mahn says. "There are opportunities for good risk-adjusted growth if you look beyond your traditional U.S. large-cap asset class."

Mahn says his firm, which has $300 million in assets under management or supervision, has pared fixed-income holdings in lieu of commodities. There is also a greater emphasis on value rather than growth, he says. "So many U.S. corporations are sitting on piles of cash and will most likely be buying back stock, buying companies or increasing their own dividends."

Other money managers take a similar stance. Banyan Partners' Pavlik, based in Palm Beach Gardens, Fla., says it would be premature for investors to take a defensive stance based on the recent jump in oil prices stemming from expectations of production shortfalls.

"You'd need real production halts to have a long-lasting, fundamental impact," Pavlik says. "So far, we just haven't seen it yet. This is all speculative trading that has been going on. You'd be making a mistake to exit out of some of these discretionary, cyclical sectors at this point because the economy is still on track and it is still growing."

Stronger manufacturing and industrial companies' higher capacity utilization underscore a healthier economy, Pavlik says. However, investors remain worried about sluggish job growth, he says.

Dearborn Partners' Nolte, based in Chicago, takes his greatest comfort that the stock market is in a short-term pullback rather than a collapse by comparing advancing to declining stocks.

"When we take a look at the advance/decline line, it hasn't changed since August," Nolte says. "That means we haven't seen a deterioration in the market internals, which is what you would normally see before any big decline. We saw that in 2007 and we saw it in 2010 before the summer swoon."

Investors should be keeping a close eye on the relationship between defensive stocks and cyclical stocks, Nolte says, as a change in leadership would also likely mark the start of a downturn.

"If we start to see the more defensive sectors outperform the cyclical sectors, that is when we will change how we go about things," he says. "So far we haven't."

These money managers find opportunities for investors in energy, materials and industrials, which TheStreet details on the following pages along with areas that investors should be concerned about.


As the protests have been staged in countries known for their oil output, crude prices have rocketed on supply-and-demand concerns, jumping above $100 a barrel. Gasoline prices have also climbed across the U.S.

With the rapid increase in oil prices, energy stocks are most attractive to money managers. Since crude spiked Feb. 18, 15 of the top 25 performing stocks on the S&P 500 are energy-related companies, including Chesapeake Energy ( CHK) and Chevron ( CVX).

The uprising in Libya ignited the jump in crude prices, but Mahn argues that the bigger threat is the contagion spreads across the Middle East. "It's a bigger concern especially if it spills over into Saudi Arabia and some of the bigger oil-producing countries."

Mahn cites a recent report by the U.S. Energy Information Administration (EIA) that states the U.S. is the third-largest producer of oil in the world, behind only Saudi Arabia and Russia. "We supply 50% of our own consumption," he adds. "Libya is a concern, and it will have an impact on short-term oil prices. But Saudi Arabia will step in and fill in any gaps. I don't think it will cause that many disruptions in the oil market."

While Mahn declines to make specific equity picks in the energy space, Nolte offers Exxon Mobil ( XOM) as his pick, noting the company's international exposure, revenue growth, access to capital and dividend payment.

Over the past two months, Exxon Mobil shares have jumped 16% to $85, its highest level since 2008. Even still, the company has a price-to-earnings ratio of 13.7, which signals the stock may still have value as it is below the S&P 500's P/E ratio. Exxon shares also have a yield slightly north of 2%, which provides investors with extra income.

But not every professional investor is rushing into the energy space. Pavlik notes that several of these energy stocks have run higher and the opportunities are slim in numbers. "You have to be careful with the energy sector," he warns. "Specifically, figuring out which names will benefit and which names have moved so much that it wouldn't pay to be a buyer."

Instead, Pavlik highlights the financial sector, which he says should benefit from an increase in interest rates. Specifically, he's high on Bank of America ( BAC) and Citigroup ( C).

"The banks are able to lend out at a higher rate and borrow at a cheaper rate from the Federal Reserve, and thus seeing an increased spread," he says. However, Pavlik does acknowledge that bank stocks still have some risk and aren't out of the woods yet.


Not only has crude spiked higher, but gold has continued to hit record highs due to the so-called flight to quality. Since the uprising in Egypt began on Jan. 25, gold prices have rallied from $1,320 an ounce to a high of $1,440.10 on March 2.

But oil and gold aren't the only commodities on the rise. Silver, cotton and other commodities have surged on inflation fears. For instance, the iPath Dow Jones-UBS Cotton Subindex ETN ( BAL) is up more than 45% this year.

"Thankfully for ETFs and ETNs, we were able to take advantage of food inflation," Mahn says of his firm's success. "What's at the core of a lot of the unrest right now was the fact that there is high unemployment and citizens are starving because food prices are so high. We invest in certain ETFs that would benefit from rising food prices."

While the money managers are steadfast in their assertion that the market is not in freefall, Mahn notes that the threat of inflation is "very real" and investors should do their best to get ahead of the curve.

"For those, including the Federal Reserve, who say that inflation isn't something to be concerned with as of yet, it is something very near and dear to most Americans and citizens around the world," Mahn says. "Investors need to stay ahead of that curve and shouldn't wait for the Fed to raise interest rates to deal with inflation for them."

Mahn says his firm has put money in metal-based commodities, such as gold, copper, steel and silver, which he says fuel the development of the international world. The money is still flowing into gold, but Mahn argues that "silver may be something worthy of consideration since it has more industrialized uses."

Pavlik, meanwhile, turns to agriculture and commodity stocks as a way to play concerns over inflation. "I'd position myself in the materials sector because of the higher costs that people are worried about," he says.

Sygenta ( SYT) and Bunge ( BG) are Pavlik's top picks for the agriculture space as they have flown under the radar as Deere ( DE) has gotten more attention from investors.

"I'm looking for other opportunities," Pavlik says. "We've been early on with Bunge. They're not often discussed and are overlooked by the retail investor. There's nothing wrong with other agriculture names, but some have made a big move already."


U.S. industrial stocks remain a popular pick for money managers as many are multinational companies that benefit from a weak dollar, pay a dividend and still can sell their goods abroad. Given hopes of a global recovery as well as the creation of a middle class in many emerging markets, these stocks still remain attractive, money managers say.

Nolte picks out Caterpillar ( CAT), Air Products ( APD) and Emerson Electric ( EMR) as his best plays in the industrial sector for very simple reasons.

"All of those companies have international exposure, so they're not strictly domestic companies," he says. "They all have good revenue growth, good access to capital. Even if the market or the economy slows down, they will continue to do well and take market share from the weaker companies."

Pavlik also likes the industrial sector as a play on global recovery. "I still think the world is in a growth phase and it's still early on," he says. "I don't think it is as tenuous as people treat it to be."

Pavlik singles out Boeing ( BA) and 3M ( MMM), noting dividend yields that are just under 2.5% on each stock.

For Boeing, he says the stock has and will continue to benefit on expectations for the delivery of the company's 787 Dreamliner jet. In regards to 3M, Pavlik says people will have more discretionary income, leading to the purchase of 3M's consumer-driven products.

Sectors to Avoid Now

Emerging markets represented one of the hottest sectors of last year, with the SPDR S&P Emerging Markets ETF ( GMM), iShares MSCI Emerging Markets Index ( EEM) and Vanguard Emerging Markets Stock ETF ( VWO) up 15% or more in 2010.

Food-price inflation, though, has taken some of the shine off emerging-market investments. This year, those same ETFs are each down more than 3%. Meanwhile, China's red-hot economy has forced the country's central bank to raise key interest rates three times since October to combat inflation.

"From an asset-allocation perspective, we've shied away from emerging markets since the end of last year," says Nolte. "They just have not performed well. Part of that reason is the issue of higher energy and commodity costs. It's having an impact on those economies."

Beyond emerging markets, Pavlik says U.S investors should watch Europe, as any impact associated with the Mideast crisis would like be felt across the pond first.

"We're seeing some signs of higher inflation in Europe already," he says. "The positive take-away from that is that Europe is contributing less to the global recovery than other places of the world like Asia or the U.S. It will be fairly contained unless that trouble continues to spread to a more sensitive area, like Saudi Arabia. The other leaders in the Arab world realize that they have to pacify their people before they're the next to fall."

-- Written by Robert Holmes in Boston.

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