Staples, Utilities and REITs Look Risky as Valuations, Bond Yields Rise

NEW YORK (TheStreet) - U.S. stocks are notably lower on Tuesday, with the S&P 500 falling 0.9% as bond yields continue to move higher ahead of Friday's non-farm payrolls report for the month of April. 

Before deciding whether the market will rally or pullback, investors should wait to see the results from the labor report, Joseph Terranova, senior managing director at Virtus Investment Partners, said on CNBC's "Fast Money Halftime Report." 

As bond yields continue to rally, Terranova said he doesn't like stocks that have high dividend yields, as they become less attractive compared with higher-yielding bonds. These include utility stocks, REITs, and MLPs

Even if interest rates and bond yields don't go higher, it's hard to buy MLPs, REITs, utilities and consumer staples stocks because the valuations are far too high, according to Rich Pzena, co-founder and chief investment officer at Pzena Investment Management

Outside of these sectors, equities are "fairly priced," while forward earnings multiples are roughly in line with their long-term averages, Pzena added. Interest rates however, remain "way, way, way below average," he said. 

It seems like investors have had trouble believing in the validity of the market rally over the past few years, Terranova said. Because of this, many investors have been buying "high quality" stocks like utilities and staples, but in the process, they've pushed the valuations up to levels that are too high. 

"The economy is looking better in my view," said Stephen Weiss, founder and managing partner of Short Hills Capital Partners LLC. Because of this, bond yields have been going higher as investors sell out of bonds. Stocks continue to look like the most attractive investment around. 

European bond yields have had a huge rally lately, pointed out Jon Najarian, co-founder of optionmonster.com and trademonster.com. That seems to have caused selling pressure in European stocks, particularly in German equities. The European Central Bank's commitment to buy $1.1 trillion worth of bonds will likely keep downward pressure on bond yields. 

The recent rally in bond yields has given a boost to bank stocks. In particular, Bank of America (BAC) has done well, up 5.5% in the past five days, Weiss said.

On Monday, hedge fund manager David Einhorn gave a bearish presentation on fracking companies. While Terranova agreed that there will certainly be companies that struggle mightily in the industry, the stocks that Einhorn selected to suffer significant declines didn't make sense. 

Terranova argued that stocks like Concho Resources (CXO), Pioneer Natural Resources (PXD) and EOG Resources (EOG) will be the stocks that do well. Shares of Pioneer Natural Resources will not decline to sub-$80, like Einhorn suggests, if oil prices stay near current levels, he said.

If oil falls below $40, however, many fracking companies will be in trouble, Terranova noted. 

Pzena took the other side, arguing that if oil prices stay near current levels, these stocks are "definitely going down." Fracking stock valuations are too high unless oil prices rally significantly from current prices, he said, adding that in the short-term, oil prices will be what moves energy stocks up or down. 

Many of the "unexciting" oil companies, like Exxon Mobil (XOM) and Royal Dutch Shell (RDS.A) (RDS.B), have skipped the "exciting" fracking business, and therefore fell out of favor with investors, Pzena said. These companies are more interested in stable earnings and cash flows from business opportunities that last several decades.

Najarian says he would be leery of fracking stocks because many companies have high-yield debt that comes due later this fall. On the bull side though, prices on everything from housing to equipment has fallen for these companies, now that oil prices have declined so drastically.

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