Sector Detector: Financials bursts to the top
The defensive posture taken by Sabrient’s fundamentals-based SectorCast-ETF model has allowed the long/short model portfolio to prosper in the face of the market weakness we’ve seen over the past week. The formerly hot Materials sector had begun to show signs of cooling off last week even as the overall market was hitting new highs, and over the past week it fell hard.
Also, I said last week that I was eager to see how the perennially top-ranked Healthcare sector would react to the Scott Brown victory in the Massachusetts senatorial election, and in fact it has sold off a bit more than the SPY…and dropped in our rankings for the first time in a quite awhile.
Latest rankings: This week, Healthcare is no longer in the top two for the first time since October. Furthermore, we have seen a huge move in Financials (XLF), which has made an impressive jump of 30 points – from 51 last week to 81 today. Other than those two, there are only minor changes in the relative scoring among sectors. Utilities (XLU) stayed in second place with a score of 79. These two sectors boast the lowest aggregate projected price to earnings (P/E) ratios. XLF is also powered by its top score in projected year-over-year change in earnings across the sector. XLU is particularly strong in its aggregate return on sales. 
In the middle of the pack, InfoTech (IYW) continued to strengthen with additional analyst upward earnings revisions among its constituent stocks during the week, and it is now challenging Healthcare for third place.
Top-ranked stocks within XLF and XLU include Travelers (NYSE: TRV), Goldman Sachs (NYSE: GS), Florida Power & Light (NYSE: FPL), and Teco Energy (NYSE: TE).
At the bottom of the rankings, we continue to find Materials (XLB) and Industrials (XLI) lurking about. XLB remains the fundamentally most overvalued sector with a low score of 35, and its technical strength has evaporated as the dollar has stabilized and China has indicated a desire to rein in its rapid growth rate. XLB still sports the worst aggregate projected P/E. XLI scored a 37 as it remains saddled with a poor projected year-over-year change in earnings across the sector.
Low-ranked stocks within these sectors include U.S. Steel (NYSE: X), Titanium Metals (NYSE: TIE), PACCAR (Nasdaq: PCAR), and Textron (NYSE: TXT).
These scores represent the view that Financials and Utilities stocks may be undervalued overall, while Materials and Industrials stocks remain overvalued.
Performance: The table below shows the performance of each of the prior four weekly portfolios as of the market close on Tuesday, 1/26/10.
The sudden and rapid deterioration in the technical strength of Materials has been the main driver behind the strong performance of Sector Detector’s long/short model portfolio. And it continues to demonstrate the value in an absolute return approach to the markets.
Disclosure: Author has no positions in stocks or ETFs mentioned.
About SectorCast: The rankings are based on Sabrient’s SectorCast model, which builds a virtual profile of each of the 10 ETFs in the table below based on bottom-up scoring of their constituent stocks. The model employs a fundamentals-based multi-factor approach including forward valuation, earnings growth prospects, analyst revisions, and various return ratios.
SectorCast has tested to be highly predictive for identifying the best (most undervalued) and worst (most overvalued) sectors, with a 1-month forward look. Of course, each ETF has a unique set of constituent stocks, so the sectors represented will score differently depending upon which set of ETFs is used. For Sector Detector, I use 8 Select Sector SPDRs, but because the SPDRs combine InfoTech and Telecom into one ETF, I use the two iShares for those sectors rather than the SPDR Select Technology ETF.
About Trading Strategies: Sector Detector has shown how you can use this information in three ways to identify ETFs that have the potential to enhance your upside, downside, or market-neutral trading ideas. First, if you are bullish on the broad market, you can go long the SPDR Trust exchange-traded fund (SPY), which tracks the S&P 500 Index, and enhance it with long positions in SectorCast’s top-ranked sector ETFs. Conversely, if you are bearish and short (or buy puts on) the SPY, you could also consider shorting the two lowest-ranked sector ETFs to enhance your short bias.
However, if you really don't want to bet on which way the market is going, you could try a market-neutral, long/short trade—that is, go long the top-ranked ETFs and short the lowest-ranked ETFs. And here’s a more aggressive strategy to consider: You might trade some of the highest and lowest ranked stocks from within those top and bottom-ranked ETFs, such as the ones I identify above.
About Performance Tracking: I track each week’s set of ETFs as a mini-portfolio over the course of four weeks. Because SectorCast does not include any technical triggers, this will give the fundamentals-based model a chance to achieve its predicted move.