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05/26/17 05:07:25 PM

Two Sector Weighting Changes

CFRA's Investment Policy Committee voted to upgrade both energy and utilities to marketweight from underweight.

"Valuations in these sectors increasingly look reasonable to us," says Sam Stovall, CFRA's chief investment strategist.

Regarding the energy sector, CFRA Energy Equity Analyst Stewart Glickman notes that at its semi-annual meeting last week in Vienna, OPEC agreed to extend its production cuts of about 3.6%. The extension is for nine months, or until March 2018. In addition, he sees exploration & production, as well as midstream companies, trading at discounts to historical forward average price-to-cash-flow multiples, using 2018 estimates. Also, older wells in the Permian Basin are declining almost as fast as the new wells are increasing production. This trend will likely help keep upward pressure on West Texas Intermediate oil prices, which Glickman projects averaging above $50/barrel through 2018.

"The energy sector is emerging from a deep earnings recession and is projected to serve as a tailwind in 2017 and beyond, rather than the headwind it represented in 2015 and 2016," adds Lindsey Bell, CFRA investment strategist.

The energy sector accounts for 6.3% of the S&P 500. CFRA has 5-STARS rankings on nine U.S.-listed energy stocks: Baker Hughes (BHI 55 ), Canadian Natural Resources (CNQ 30 ), Consol Energy (CNX 16 ), Diamondback Energy (FANG 99 ), Encana (ECA 11 ), EOG Resources (EOG 90 ), Magellan Midstream Partners (MMP 74 ), Suncor Energy (SU 31 ), and WPX Energy (WPX 11 ).

For a diversified approach to investing in the sector, one might consider Energy Select Sector SPDR ETF (XLE 66 Marketweight), which boasts an expense ratio of 0.14%. EOG is one of its top-10 holdings. Other names in the ETF's top 10 are Schlumberger (SLB 70 ), ConocoPhillips (COP 45 ), Occidental Petroleum (OXY 61 ), and Kinder Morgan (KMI 19 ). Todd Rosenbluth, CFRA's director of ETF research, notes the credit ratings of the underlying holdings of the ETF are generally good, and the ETF trades with an attractive bid/ask spread.

Turning to the utilities sector, CFRA Utilities Equity Analyst Christopher Muir foresees utilities benefiting from higher numbers of customers, driven by the slowly growing U.S. economy; rate increases driven by strong capital spending for aging infrastructure replacement; and capital spending on new projects to address load growth, i.e., increase in energy demand. "While NOAA (National Oceanic and Atmospheric Administration) forecasts a warmer-than-normal summer in the heavily-populated U.S. coastal regions, we see generally lower air conditioning demand following an extremely warm summer in 2016, which is pressuring earnings growth in 2017," Muir explains. "Electric utility valuations seem reasonable to us, given the slow pace of interest rate increases that we expect."

The utilities sector makes up 3.2% of the S&P 500. CFRA has 5-STARS rankings on two U.S.-listed utilities stocks: Exelon (EXC 36 ) and National Fuel Gas (NFG 57 ). For a diversified approach to investing in the sector, one might consider Utilities Select Sector SPDR ETF (XLU 53 Overweight), which boasts an expense ratio of 0.14%. Exelon is one of its top-10 holdings. Other names in the ETF's top 10 are Sempra Energy (SRE 115 ), NextEra Energy (NEE 141 ), and Duke Energy (DUK 85 ). Rosenbluth notes the underlying holdings of the ETF generally receive positive (meaning low) Qualitative Risk Assessment scores from CFRA equity analysts. He also notes the ETF trades with an attractive bid/ask spread.

CFRA maintains an overweight recommendation on the industrials and materials sectors, and reiterates its underweight bias for consumer staples and real estate.

Beth Piskora, CFRA Senior Content Director


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