Salomon convertible analyst ups energy, cuts financial weightings

By Ronda Fears

Nashville, Tenn., Feb. 13 - Salomon Smith Barney convertible analyst Adrian Miller boosted recommended holdings in energy to slight overweight from market weight and cut the financial sector to a market weight from a slight overweight, to mirror the firm's equity strategists' shift in asset allocations to position for the anticipated economic growth over the next six to 12 months.

"The past 13 months have witnessed a uniformity in declines between the S&P 500, S&P financial index and the S&P energy index. However, in the convertible market, financial convertibles have provided excellent support to the overall market while energy convertibles have experienced a far more dramatic decline than the overall convertible market in general and finance convertibles in particular," Miller said in a report Wednesday.

"Consequently one could argue that with improving fundamentals within the energy groups and the possibility of stagnating results within the financial sector, these groups within the convertible market could witness an even more dramatic reversal of fortunes than the broad equity market."

The analyst noted that as of Jan. 31, finance issues made up 12.2% of the convertible market while energy issues accounted for 6.0%. On a comparative note, he noted that the revision of these two groups leaves their respective weightings in the Salomon recommended portfolio asset allocation at 17.7% and 7.6%.

Changes to the financial sector are based on several factors, not the least of which is the belief that because of the unusual nature of the current economic cycle, the positive effects of a recovery on financials will be muted relative to past instances.

"This cycle is unusual in that financials have already seen a marked improvement in profitability early on. Usually, if our sector analysts are correct, bank profitability should be depressed. While we don't believe that 2002 will be a bad year for these stocks, we do not foresee the improvement versus the market that we would have seen in a traditional cycle," Miller said in the report.

"Our strategists also believe that the energy sector should attract a greater amount of money in the coming months. In November, we raised the sector from an underweight to a market weight, under the premise that as the economy expands at a greater rate, demand for energy should pick up. Given what we have observed during the past several weeks, we are even more certain that the path to recovery is indeed on track and energy prices should firm up as the economy resumes strong growth. We also believe OPEC does not possess the same level of control over the world's oil supplies as has been the case in the past, thereby making oil prices more tied to economic activity than traditionally has been the case.

"In November, our strategists highlighted the fact that the energy group was trading at a 30-35% discount to the market. This had happened only once before, in late 1985, after which the sector outperformed by 30% in the next two years. While the relative earnings multiple has bounced back since November, it still remains at the low end of its historical range. Our strategists continue to believe that on a risk-reward basis, this sector is one of the most attractive."

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