The Investment Column: Insurance and oil head the sectors to watch in 2007

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The Independent Online

We published our share tips for the new year at the start of the week and our recommendations focused on London blue-chip stocks for what were largely company specific reasons. But which sectors are likely to perform best in 2007?

The consensus in the City is that economic growth will slow over the next 12 months, which in turn will moderate earnings growth. This means that cyclical industries like engineering, consumer and electrical goods and so-called general industrials are best avoided.

However, the insurance sector, which did well last year, should continue to perform strongly. It has consistently beaten analysts' expectations for nearly two years and there is little to suggest that this trend is about to change. Meanwhile, insurers trade at a discount to the wider stock market. Aviva, for example, is valued at just 10 times forward earnings, while the FTSE 100 trades at over 12 times.

The oil sector also looks set to do well. BP saw its shares price lose ground last year while Shell finished flat on the year. One reason for this underperformance is that many investors have taken money out of the mega-cap stocks that make up the industry and put it into smaller companies vulnerable to takeover in an attempt to capitalise on the M&A boom.

This boom has been partly driven by private-equity buyouts and although the average deal size has risen sharply it is impossible for a financial buyer to ever be in a position to acquire BP or Shell (which are worth more than £100bn each). This has left the oil sector valued at a historically low multiple of earnings. So low, in fact, is the sector's valuation that it implies a crude price of around $40 a barrel compared with the going rate of $60.

Healthcare is another example of a sector de-rated by investors because it is unlikely that many of its major players will ever be taken over. Analysts now point out that the sector trades at a multiple of earnings so low that it has not been seen since the early 1990s.

Healthcare stocks are a great bet when the wider economy is starting to slow. Traditionally they outperform during such periods and given their low valuation, and strong earnings momentum, there is no reason to believe healthcare will not do so again this time around.

Finally, readers would do well to have a look at the technology sector in 2007. In Europe, it has suffered because of persistent downgrades to earnings.

But the story in the US has been very different. There, earnings estimates have been on the up, prompting a solid performance by technology stocks since the summer. Historically, the US sector takes the lead and many analysts expect Europe to follow suit in the months ahead.

SR Pharma

Our view: Buy

Share price: 58.25p (+1.5p)

The biotech company SR Pharma is a key player in a hot new area of gene-based drugs called RNA Interference (RNAi) therapeutics. This technology blocks or "silences" genes and is expected to play a pivotal role in the development of treatments for diseases such as cancer, Aids and blindness. The scientists behind the discovery - Dr Andrew Fire and Dr Craig Mello - were awarded the Nobel Prize for medicine last year. The technology moved further into the spotlight in October after Merck acquired the US biotech specialist Sirna Therapeutics, another leader in the field, for $1.1bn (£50m).

Yesterday, SR Pharma was granted a patent by the European Patent Office for its core RNAi compound. The announcement sent its shares 3 per cent higher to 58.25p, valuing the AIM-listed company at around £65m. This is the first patent to be granted for a new class of molecules known as AtuRNAi which form the basis of SR Pharma's pipeline for cancer treatments.

The company's share price has been building momentum since October when it signed a $95m licensing deal with Pfizer for its RNAi compound used to treat age-related macular degeneration (AMD) eye disease.

Yet despite the performance of SR Pharma shares - they have risen by 35 per cent in the past month alone - there is plenty more upside for investors. The group is due to start its first clinical trials in the cancer field later this year which should help to drive the shares higher.

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