By Sam Stovall Please note: Sam Stovall's Sector Watch will not be published on Aug. 20. It will return on Aug. 27.

One name that has been on the list of industries with top Standard & Poor's Relative Strength rankings for several months now is Water Utilities. The group has managed to find its own level in 2002 amid a slide in the overall market. Year to date through Aug. 9, the S&P Water Utilities subindex slipped 0.1%, vs. a 20.2% decline for the S&P 1500 index (the combined S&P 500, S&P MidCap 400, and S&P SmallCap 600 indexes). During the past 13 weeks, the group fell 6.3%, vs. a 16.3% slide for the market index.

S&P analyst Stewart Scharf recently upgraded his investment outlook for the water-utilities group to positive from neutral. He says water utilities should benefit as economic conditions improve, while in the near term, the shares should be supported by investors seeking total return -- dividends plus capital appreciation -- and by the group's defensive appeal.

Water utilities are expanding geographically in an effort to reduce the impact of adverse weather. (Water-use restrictions only recently eased in the Northeast as reservoirs improved to near-normal capacity.) Utilities are also seeking -- and being awarded -- rate hikes to offset rising infrastructure costs. Scharf expects Congress to allocate at least $20 billion to water companies during the next five to seven years for water-system infrastructure improvements.

FOREIGN STAKE. And more financial help is in the pipeline. In November, 2001, the Bush Administration decided to adopt a new standard, which it had suspended in March, 2001, to reduce arsenic levels in drinking water to 10 parts per billion from 50 ppb. In order to comply with the new standard, water-system operators, both municipal and private, would receive $57 billion over five years to help make up a funding gap in capital outlays. Private water outfits serve about 15% of the U.S. population.

One notable trend in recent years: Many companies in the industry have been snapped up by non-U.S. utilities. More foreign acquisitions are possible, notes Scharf, although France's Vivendi Environment plans to sell via a secondary public offering its remaining 16% stake in Philadelphia Suburban (PSC

) as part of a plan to divest noncore assets in the regulated U.S. market.

Philadelphia Suburban, which accounts for 22% of the Water Utilities subindex's market capitalization, recently agreed to acquire DQE's (DQE

) AquaSource water unit for about $205 million. Based on completion of that deal, Philadelphia Suburban will become the largest publicly traded U.S.-based water utility when American Water Works (which accounts for 72% of the index's market cap) is acquired by Germany-based utility RWE during the first half of 2003.

Philadelphia Suburban remains Scharf's top choice in the group. It carries an S&P investment ranking of 4 STARS, or accumulate.

S&P Relative Strength RankingsThese industries carry 12-month relative strength rankings of "5" as of Aug. 9, 2002 -- meaning that they're in the top 10% of the 114 industries in the S&P Super 1500 (the combined S&P 500, S&P MidCap 400, and S&P SmallCap 600) based on prior 12-month price performance.

Industry/Sector

Largest Company (Market Cap.)

S&P STARS* Rank

Brewers/Consumer Staples

Anheuser-Busch (BUD)

4 STARS

Casinos & Gaming/Consumer Discretionary

Harrah's Entertainment (HET)

4 STARS

Commodity Chemicals/Materials

Lyondell (LYO)

3 STARS

Distillers & Vintners/Consumer Staples

Constellation Brands (STZ)

5 STARS

Gold/Materials

Newmont Mining (NEM)

4 STARS

Homebuilding/Consumer Discretionary

Clayton Homes (CMH)

5 STARS

Household Products/Consumer Staples

Procter & Gamble (PG)

5 STARS

Housewares & Specialties/Consumer Discretionary

Fortune Brands (FO)

5 STARS

Managed Health Care/Health Care

UnitedHealth (UNH)

5 STARS

Metal & Glass Containers/Materials

Pactiv (PTV)

5 STARS

Water Utilities/Utilities

Philadelphia Suburban. (PSC)

4 STARS

*S&P's ranking system for the appreciation potential of stocks over a 6- to 12-month period: 5 STARS (buy), 4 STARS (accumulate), 3 STARS (hold), 2 STARS (avoid), 1 STAR (sell). Stovall is chief sector strategist for Standard & Poor's