3 Heart-Poundingly Cheap Sectors

05/20/2011 11:58 am EST

Focus: MARKETS

Jack Ablin

CIO & Executive Vice President, BMO Private Bank

Longtime hot performers like materials and industrials are beginning to peak, but these three areas remain undervalued...and perhaps overwhelmingly so, says Jack Ablin of Harris Private Bank in this exclusive interview with MoneyShow.com.






So Jack, tell us what your overall market strategy and timing is telling us today.

Well, so far, if you just look at the dials, which are:

  • valuation
  • economy
  • liquidity
  • psychology
  • momentum

All of these are still pointing in a pretty positive direction, and that says we're still all systems go. The problem is, it's really what the dials aren't measuring that has me concerned—and that is all of the stimulus...all of these financial props, both monetary and physical, and that eventually we're going to have to pull away—and that could lead to some pullback in demand.

But you're still significantly above your ribbons in terms of your technical market timing that we've written about and followed very closely at MoneyShow.com.

We are. We are above our breakout band, and it does suggest that we should stay in—and we are in.

But I will say every month I'm looking over my shoulder at economic data. I’m looking at what the Fed is likely to do, or in this case not do, and I am concerned that we are spending $1.6 trillion more than we're bringing in at the federal level, and that's creating somewhat of an illusory economy that eventually we're going to have to pull back.

Where are you with your sectors? You had taken a pretty big position in the ETFs. You are one of the largest if not the largest ETF investor. I remember you had gone into the Ivy and some of the other big-cap sectors.

Yeah, in terms of overall market mix, we still like the large caps. We like value. We're starting to shift toward looking for growth.

We pulled out, pretty much lightened up in small cap. We are underweight in emerging markets, and we have been for probably—I don't know—18 months or so. We do like SPDR S&P International Small Cap ETF (GWX), and we like commodities.

How much of an allocation?

Well, we have right now a 10% allocation to commodities, and up to half of that we can have in ENY, so 5% of the portfolio. It's a pretty significant piece.

But here's the premise, Charles: We have crude oil pushing $100 a barrel, but if you look at natural gas on a BTU-equivalent basis, you can deliver the same output as a barrel of oil for $26—for a little more than a quarter of the price.

These oil-sands facilities, their output is crude. The big input cost is natural gas. So as long as that spread stays wide, these companies are going to make a lot of money.

I'm sorry…you're telling me that the oil sands are producing [crude] at $26?

Well, they use natural gas to harvest crude. This spread between crude oil and natural gas, which is now 4:1 on a BTU-equivalent basis, is as wide as I've ever seen.

And it will likely stay wide because, again, these two commodities are not economic substitutes. You just can't simply start filling your car up with natural gas when gasoline gets too high.

Because of this spread, it's almost like a refining-type spread. They produce crude, and they use natural gas to produce crude. As long as that spread stays wide, those profits will drop to the bottom line.

Any other sectors you're looking at?

Our sector preferences right now are still pro-cyclical, so we like the basic materials, industrials, consumer discretionary, and I think we have actually telecom mixed in there too. Those sectors through their run have gotten relatively expensive, and starting to lose a little momentum.

We're looking on deck, and that's health care. We're not there yet, but I will say health care is, in my view, table-poundingly cheap, and starting to exhibit a little relative strength.

Which sectors? Would that be a really broad look, or...

We use a broad basket, but certainly pharma, devices, and biotech. I think they're all pretty well represented, and I think probably all should be held; but just collectively, if you look at the relative valuation of health care compared to the other nine sector groups, they're about as cheap as finance was back in the beginning of 2009.

That’s very good!

So, we're waiting. We just need it to percolate a little bit and get a little more investor attention; but when it does, I think it should be a home run the second half of this year and probably in the next.

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