LP L FINANCIAL R E S E AR C H
Raging Bull
David Reilly, CFA
Equity Strategy
LPL Financial
John Canally, CFA
Vice President
LPL Financial
Jeffrey Kleintop, CFA
Chief Market Strategist
LPL Financial
Jeffrey Buchbinder, CFA
Equity Strategy
LPL Financial
Highlights
We have increased our recommendation on the
Energy sector to market weight due to our view
that a break in oil prices may not occur until the Fed
raises rates and the dollar strengthens.
In the interim, we believe equity markets will
remain volatile and that a market weight position in
Energy will serve to buffer this volatility.
The Energy sector moves in step with oil
commodity prices, and we expect this relationship
to continue.
Our view is that earnings, valuations and technical
factors follow movements in the price of oil and
therefore are less relevant as leading indicators of
sector performance.
The risk to our neutral view on the Energy sector
is that oil prices continue to make and sustain new
highs or that a meaningful break to the downside
occurs sooner than we expect.
Within the Sector, we favor the Oil & Gas
Exploration & Production industry due to its
exposure to natural gas. We are neutral to negative
on the Integrated Oil & Gas industry due to its
exposure to the refining business and neutral to
negative on the Equipment & Services industry due
to its sensitivity to oil prices.
Important Disclosure Information:
Please refer to the last two pages for
important disclosures.
June 25, 2008
Energy Sector Overview
We have upgraded our Energy Sector
Recommendation to Market Weight based
on our outlook for range bound oil prices
during the coming months.
We have increased our recommendation on the Energy sector to market
weight from underweight as we reassess our outlook on the price of oil.
While we still believe that currently elevated oil prices do not reflect the true
underlying supply and demand for the physical commodity, the investment
demand for the financial asset of oil has pushed prices into bubble territory.
Our recommendation change reflects these realities as well as our view that a
break in oil prices may not occur until the Federal Reserve begins to increase
interest rates and the dollar strengthens. Furthermore, the factors needed to
bring about a drop in oil prices may not come to bear until later this year. In
the interim, our view is that a neutral portfolio positioning in the Energy sector
may serve to buffer investors from such volatility. Specifically, should oil prices
remain at current levels or move higher, the negative impact on economic
health will likely weigh on the broader market. In that environment we believe
a market weight exposure to Energy could serve to buoy equity performance.
Given the correlation between oil prices and the performance of the
Energy sector, much of our sector outlook is tied to the direction of this
commodity price rather than company earnings and valuation. This is also
one of the factors that drive our industry views within the sector. Another
important factor influencing our sector and industry views is the relationship
between oil prices and natural gas prices. With oil prices at these levels, we
would favor companies with exposure to natural gas. Wherever possible,
consumers have begun to switch their energy source to cheaper natural gas,
which tends to benefit companies in the exploration and production industry.
Our industry group recommendations for the Energy sector are shown
below. These are recommendations relative to the sector, which represents
16% of the S&P 500 Index. A detailed rationale for each of our industry
views can be found in the final section of this report.
ENERGY SECTOR RECOMMENDATION: OVERWEIGHT
Industry Group Weight in Weight in Recommendation Recommendation
Sector (%) S&P 500 (%) Change
Integrated Oil & Gas 54.7 8.3 Neutral to Negative
Å
Oil & Gas Equipment & Å
Services
17.0 2.6 Neutral to Negative
Å
Oil & Gas Exploration &
15.7 2.4 Positive Å
Production Å
Source: LPL Financial Research, Factset
Member FINRA/SIPC
page 1 of 7
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1 Bubble Territory We have increased our recommendation on the Energy sector to market
NASDAQ and Oil Prices weight due to our view that a break in oil prices may not occur until the
Fed raises rates and the dollar strengthens. While the supply and demand
Oil Past 10 Years
NASDAQ from 10 Years Prior to Peak for the physical oil commodity remains in balance, the demand for the
1200% financial commodity of oil is clearly out of balance, with far more investment
1000% demand than supply. The rise in the price of oil has weakened demand for
800% the commodity itself, but it has boosted demand for investments in energy-
600% related financial products, as investors have chased returns. Oil prices have
400%
been moving in a similar path to the NASDAQ in the 1990s as the physical
versus financial supply/demand relationship has decoupled. [chart 1]
200%

0% Despite the fact that we believe we are in bubble territory and that this
-200%
bubble will come to an end, history reminds us that past bubbles typically
Mar-90 Mar-92 Mar-94 Mar-96 Mar-98 Mar-00 Mar-02 required Federal Reserve rate hikes to cause that end. As you can see in
Source: LPL Financial Research / Bloomberg the nearby chart, several bubbles over the past four decades have come to
an end only when the Fed began to raise rates. This end of cheap money
usually causes speculative investors to unwind their positions, reversing the
momentum in those markets. This time, the Fed is expected to begin to
hike rates later this year. [chart 2]
There has also been a correlation recently between oil prices and the value
of the dollar relative to the currencies of our major trading partners. As the
dollar moved lower, investors have been moving into oil futures, viewing
this commodity as a safe haven and thus bidding up the price. Furthermore,
since oil is priced in dollars, a falling dollar currency relative to other major
currencies makes oil less expensive if, for example, you are using euros
to purchase it. While we expect a firmer dollar to weigh on oil prices, this
scenario has not yet begun to occur.
In addition to rate hikes and expected dollar strength, we believe there are
other factors that may also begin to weigh on the price of oil as we enter the
fourth quarter of this year. Typically, the fourth quarter is seasonally weak for
oil prices as the summer driving season comes to an end. Also, the threat
of hurricanes begins to abate as we move into September. Finally, in the fall
of this year as the Beijing Olympics come to an end, we expect investors
will begin to focus on slowing growth in China and other emerging markets.
2 Fed Rate Hikes Have Ended Past Asset Bubbles In fact, there is generally a cycle of increasing economic growth in the host
Federal Funds Target Rate and Peak of Past Asset Bubbles country ahead of the Olympic Games and then a tailing off of growth once
Labeled - Forecast in Blue
they conclude. We expect China, which has been a big focus of oil investors,
25 to experience a similar slowdown later this year.
Gold at $835

20
In the interim, we believe equity markets will remain volatile and that
“Nifty Fifty” Dollar Peak a market weight position in Energy will serve to buffer this volatility.
15 Nikkei Peak
Oil? With oil prices having surged to levels that are stressing the economy, we
Internet Bubble
Mexico Debt Crisis believe equity markets are likely to remain volatile and range bound during
10 Housing Boom
the summer months. Oil prices at these levels continue to pressure the
5 consumer and thus weigh on the health of the economy. Until there is
a break in this commodity price, the direction and strength of economic
0
1971 1975 1979 1983 1987 1991 1995 1999 2003 2007 2011
growth remain in question, causing investors to be cautious on the equity
markets. Therefore, we believe that a market weight exposure rather than an
Source: LPL Financial Research / Bloomberg
underweight to the Energy sector will serve as a buffer to this uncertainty.

LPL Financial Member FINRA/SIPC page 2 of 6

 RAGI N G B UL L

The Energy sector moves in step with Oil prices and we expect this
3 Energy Sector Performance Tracks Oil Prices
relationship to continue. Since we have discussed oil prices in relation
Crude Price
to our view on the Energy sector, it’s important to review the relationship
S&P 500 Energy Sector
of oil prices and equity returns in this sector. As you can see chart 3, the
150 700
650 Energy sector tends to move in step with the price of oil. While there are
125 600
550
short periods when this relationship fades, over the long run they generally
100 500 move together. In addition, different industries within this sector are more
450
$75 400
sensitive to movements in the underlying commodity price than others. For
350 example, the Equipment and Services industry tends to be highly correlated
$50 300
250 and sensitive to oil price changes, while the Integrated Oil & Gas industry is
200
$25
150
less sensitive. Due to this relationship, our view on the Energy Sector as a
$0 100 whole and the industries within it are tied to our outlook on the commodity
1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

Past Performance is no guarantee of future results.
price.
Our view is that earnings, valuations and technical factors follow
movements in the price of oil and therefore are less relevant as leading
indicators of sector performance. With oil prices at these levels, we
believe the stocks in this sector are not trading based on fundamental
factors, such as earnings and valuation. Therefore, in our analysis of this
sector, improving analyst earnings expectations and seemingly attractive
valuations are less important factors in our outlook. More specifically,
earnings growth and earnings revisions for this sector are strong. For 2008,
consensus earnings expectations for the sector are for 28.8% growth,
and these have been revised up since the end of the first quarter by 13%,
as you can see in the nearby table. Of course these expectations have
been increasing with the steady march higher of oil prices. Given that
these analyst expectations are based primarily on what we believe are
unsustainable levels, earnings growth and valuation are not relevant in our
view. As soon as the price of oil breaks lower, we will see expectations
reverse, and valuations will not be attractive in our view.
EARNINGS GROWTH EXPECTATIONS FOR ENERGY RISING WITH OIL PRICES
Changes in Energy sector and S&P 500 EPS growth expectations (year-over-year growth)
Energy 3/28/2008 6/20/2008 Net Change
Q2 2008 10.4% 21.6% 11.2%
2008 15.7% 28.8% 13.1%

S&P 500 Index 3/28/2008 6/20/2008 Net Change

Q2 2008 -2.1% -7.9% -5.8%
2008 14.5% 8.8% -5.7%

Technical factors for the energy sector remain bullish. However, as with
earnings and valuations, we do not believe this measure is very relevant.
Instead, the technicals will likely continue to look good until oil prices break
,and at that point we expect the sector to quickly move out of favor.
The risk to our neutral view on the Energy sector is that oil prices
continue to make and sustain new highs or that a meaningful break
to the downside occurs sooner than we expect. Given our view
on the commodity price, the risk to our upgrade to a market weight
recommendation is that prices continue their move higher. As with most
bubbles where markets are driven less by fundamentals and more by

LPL Financial Member FINRA/SIPC page 3 of 6

 RAGI N G B UL L

speculation, it is difficult to predict their duration and magnitude. Several of

the factors that combined to bring oil prices to where they are today, such as
the weak dollar, low interest rates, and geopolitical tensions, may persist. On
the other hand, a break in the commodity price that occurs sooner than we
expect would also be a risk to our recent upgrade. Two recent developments
that could cause a quicker drop in prices are first, the promise of increased
oil production from Saudi Arabia this past weekend and second, the removal
of oil subsidies in China. In short, anything that reminds investors to focus
on the fundamentals of supply and demand for the physical commodity could
cause prices to move lower sooner than we anticipate.
Within the Sector, we favor the Oil & Gas Exploration & Production
industry due to its exposure to natural gas. We are neutral to negative
on the Integrated Oil & Gas industry due to its exposure to the refining
business and neutral to negative on the Equipment & Services industry
due to its sensitivity to oil prices. Of these industries, the only change
we are making at this point is to lower our view on the Integrated Oil & Gas
companies. As with our sector outlook, much of our industry view hinges on
the direction of the price of oil.

Integrated Oil & Gas – Neutral to Negative

ƒ This industry group is the largest in the sector and has the most
diversified mix of businesses, which might suggest a neutral view.
However, our neutral to negative outlook is primarily due to the exposure
these companies have to the increasingly challenging refining business.
ƒ A continued surge in oil prices coupled with weakening demand for
gasoline has put significant pressure on refining margins for these
companies. As a result this dynamic has negatively impacted the
earnings outlook for this group.
ƒ One risk to our reduced outlook is that these margin pressures may
abate should oil prices begin to drop. Furthermore, if these companies
have greater success than expected in passing on these increased costs
to the consumer, our concerns could be overdone.
ƒ Another risk to our cautious outlook is that the diversification and
defensive characteristics of these companies could help support the
stocks if oil prices fall.
Oil & Gas Equipment & Services – Neutral to Negative
ƒ Our neutral to negative view on this group is driven by the high relative
sensitivity these companies tend to exhibit to oil prices. Despite our
view that oil prices may not move lower until later in the year, our
cautious outlook for the group is due to the heightened risk these
companies will likely face if oil prices break lower.
ƒ As oil prices move lower, capital spending by exploration & production
companies will likely slow.
ƒ The risk to our cautious outlook is that oil prices continue to move
higher, driving additional exploration and production and thus
incremental demand for equipment and services.

LPL Financial Member FINRA/SIPC page 4 of 6

 RAGI N G B UL L

Oil & Gas Exploration & Production – Positive

ƒ We remain positive on this industry group, since these companies
generally have greater exposure to natural gas, which is benefiting from
elevated oil prices and substitution away from oil.
ƒ However, even if oil prices move lower, there is still an economic
incentive to switch to natural gas. At current prices, natural gas is an
attractive substitute for oil for industrial users like utilities as well as
consumers. In our view, oil prices would need to move meaningfully
lower to remove this incentive.
ƒ One risk to our positive outlook on this industry is a precipitous decline
in natural gas prices, which could come about from a mild hurricane
season, cool summer, or forecasts for a warm winter.
ƒ Another risk to our positive view on the industry is that potential
changes in environmental regulations in Washington could increase input
costs associated with land leases, labor, and drilling rights.

LPL Financial Member FINRA/SIPC page 5 of 6

 IMPORTANT DISCLOSURES
Investing in alternative investments may not be suitable for all investors and involve special risks such as risks
associated with leveraging the investment, potential adverse market forces, regulatory changes, potential
illiquidity. There is no assurance that the investment objective will be attained.
Investing in real estate/REITs involves special risks such as potential illiquidity and may not be suitable for all
investors. There is no assurance that the investment objectives of this program will be attained.
Small-cap stocks may be subject to a higher degree of risk than more established companies’ securities. The
illiquidity of the small-cap market may adversely affect the value of these investments.
International investing involves special risks such as currency fluctuation and political instability and may not be
suitable for all investors.
The opinions voiced in this material are for general information only and are not intended to provide or be
construed as providing specific investment advice or recommendations for any individual. To determine which
investments may be appropriate for you, consult your financial advisor prior to investing. All performance
referenced is historical and is no guarantee of future results. All indices are unmanaged and cannot be
invested into directly.
Past performance is not indicative of future results. The information set forth above has been obtained from
third party sources believed to be reliable, but LPL Financial does not represent or warrant its accuracy or
completeness and is not responsible for losses or damages arising out of errors, omissions or changes to
market factors. This material does not purport to contain all of the information that an interested party may
desire and in fact, may provide only a limited view of a particular market.
Alpha: Incremental return due to non-market factors. A positive alpha indicates that the portfolio has produced
returns above the expected level at that level of risk. Alpha measures a fund’s risk-adjusted performance. It
represents actual returns less the fund’s risk adjusted performance as measured by beta, and is expressed as an
annualized percentage.
P/E Multiple – A tool for comparing the prices of different common stocks by assessing how much the market is
willing to pay for a share of each corporation’s earnings. It is calculated by dividing the current market price of a
stock by the earnings per share.
P/B Multiple - Determined by dividing current stock price by shareholders equity for the most recent quarter.
PTB - Stock price divided by shareholders equity per share.
Book Value - A company total assets minus intangible assets and liabilities, such as debt. A company’s book
value might be higher or lower its market value.
Forward P/E- Price/earnings ratio, using earnings estimates for the next four quarters. Book value yield - is the
ratio of a company’s shareholders equity to its market capitalization.

DESCRIPTION OF INDICES
Indices are unmanaged and cannot be invested into directly.
Prepared and published by Dow Jones & Co. It’s one of the oldest and most-widely quoted of all the market
indicators. The Dow Jones Industrial Average is comprised of 30 stocks that are major factors in their
industries, and widely held by individuals and institutional investors. These 30 stocks represent about a fifth of
the $8 trillion-plus market value of all U.S. stocks and about a fourth of the value of stocks listed on the New
York Stock Exchange. It is not possible to invest directly in an index.
The Nasdaq Composite Index measures all Nasdaq domestic and non-U.S. based common stocks listed on The
Nasdaq Stock Market. The Index is marketvalue weighted. This means that each company’s security affects
the Index in proportion to its market value. The market value, the last sale price multiplied by total shares
outstanding, is calculated throughout the trading day, and is related to the total value of the Index. It is not
possible to invest directly in an index.

This research material has been prepared by LPL Financial.

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