Joe Terranova: Why Natural Gas is Below $3 and Oil Refiners are Worth a Look

Virtus Investment Partners Chief Market Strategist and author of the new book, Buy High, Sell Higher Joe Terranova joined Benzinga Radio Friday afternoon to discuss some major headlines moving markets to close out the week. Below is an excerpt from our conversation. What has been the reaction today to JP Morgan's lackluster earnings release and S&P's eurozone downgrades?

Joe Terranova: Well, it's a much-needed correction in the marketplace. So, let's go top-down for one second. I play the market from the long side. I believe in the market. I think the market's going higher. December 31st, 2012, we're going to get a higher S&P 500 print than we had on December 31st, 2011. But I think the right strategy at the beginning of the year is to play it defensively. You've seen over the last couple of days much more comfort to move out of those dividend paying stocks - the McDonald's that were doing really well, the Pfizers and Merck. And it was, “OK, let's assume more risk. Let's go into the financials. Let's have the financials lead the charge - materials, buildings doing well.” I think you're getting a much-needed correction. To me, the ultimate indicator is the 10-year Treasury. You cannot have equities go up and have the 10-year Treasury continue to trade below 2%. Investors can't be rewarded on both fronts. You need flows of capital to come out of fixed income. You need folks on fixed income that are long the treasury to feel uncomfortable holding it. You need those flows to move into the equity markets for us to get higher appreciation. So, you've got a 10-year Treasury that's having an awful day in terms of yield performance for equity appreciation. It's below 1.85%. And that's going to foster an environment where you're going to get a much-needed correction in the marketplace.

What's your take, overall, on crude oil and natural gas right now?

Joe Terranova: Two things. Let's first talk about natural gas. Not enough folks recognize the importance of the federal judge putting a stay on the implementation of the Cross-State Air Pollution Rule. What was going to happen there is you would have had immediate implementation in January 2012. We'd already be doing it, where we'd be regulating admissions, and you would've seen a natural switchover - as a byproduct of the regulation - from coal-fired power generation to natural gas-fired generation. So, the stay on the implementation of that rule pushes it back. You are not going to see that rule implemented until maybe January of 2013 at the earliest. What happens in the interim is that you've got natural gas now that is certain to push toward capacity in 2012. This, in essence, was the last hope for those that believe that natural gas prices can kind of hang in there. It was the last bastion that potentially you'd be able to support prices. The judge rules on it on December 31st. It's supposed to be implemented on January 1st. So that's why natural gas is below $3. Some of the shale plays are interesting. Canada oil and gas, which worked last year - and that was a Marcellus Shale-type play. We actually talked last night on Fast Money with the TransCanada CEO. This year, you want to have more exposure to the Permian Basin and Eagle Ford types of plays. So you look at a name like CXO, which is Concho Resources - they have great exposure there. Another name you could look at is Plains Exploration (PXP). They have great exposure there, as well. So it's more this year, I think, of a Permian Basin [and] Eagle Ford type of exposure. On oil real quick, I still believe and I maintain that oil is an overweight. I don't think folks properly understand the impact that monetary easing in China will have on oil prices. China is filling their SPR currently very aggressively. They're buying a lot of physical oil [in] every place other than Iran. And just because the EU is pushing back temporarily, the decision - in maybe six months - on an embargo of Iranian oil [is coming]. I still think oil finds firmer footing here, and we continue to move back higher.

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