Sector Detector: Bulls say, “Thanks for the entry point”
After experiencing by far its worst day of 2012, the market quickly turned back up as bulls told the market, “Thanks for the entry point!” In this bullish environment, there have been few pullbacks from which to gain a better entry price on new positions. The accumulation has been unabated. So Tuesday’s weakness was greeted as a long-awaited opportunity to buy on Wednesday. The question remains, however -- is that all the pullback we’re going to get?
Without increased trading volume, bulls were just too undermanned to push through resistance levels of 13,000 on the Dow, 3,000 on the Nasdaq, and 2011 highs on the S&P 500. Riskier indexes like the Russell 2000 have fallen the hardest—but of course they were the ones that had been rising the fastest. Not surprisingly, weakness in stocks has coincided with strength in the dollar.
Wednesday’s bounce was attributed to a variety of positive events. First, ADP payrolls data was strong, giving optimism about Friday’s upcoming jobs report. Next, apparently the Fed is considering—as their latest incarnation of quant easing—printing dollars to buy long-term mortgage or Treasury bonds, and then borrowing it back for short periods at low rates, which would make it less likely to create inflation.
Furthermore, there was some optimism that Greece’s debt swap would be successful. Thursday is the deadline for bondholders of Greek debt to sign on to participate, so it could be a market-moving day.
However, many of the debt holders remain skeptical that Greece will be able to pull off their austerity commitments. In fact, some expect that voters will install a new government that ultimately rescinds their commitments.
I think there might have been a Super Tuesday impact on the market, as well, since Mitt Romney is widely considered to be the candidate that gives Republicans their best chance at unseating President Obama. His victory in Ohio may have guaranteed him the nomination.
Among the 10 U.S. sector iShares, Materials (IYM) sold off hard on Tuesday, and it has been by far the weakest performer this week. Utilities (IDU) and Consumer Services (IYC) have held up the best. Financial (IYF) was the big leader on Wednesday, but only made up about half of its big -2.2% loss on Tuesday.
Let’s talk about Apple Inc. (AAPL). As expected, the juggernaut unveiled the newest version of its iPad tablet, which features an ultra-high-definition “retina” display, a faster processor, a high-def 5MP iSight camera, voice dictation software, and optional 4G LTE wireless networking connectivity. You can’t not like this company—whether as a consumer or an investor…or as a casual observer. It seems that Apple never fails to surprise us with innovation and exceeding expectations. Its app store is expanding exponentially. Customer loyalty is off the charts (just ask my daughters). The largest market cap company in the world remains one of Sabrient’s favorites.
Sabrient’s “Baker’s Dozen” Top Stocks for 2012 continue to power ahead of the S&P 500 performance, led by Seagate Technology (STX), Western Refining (WNR), United Rentals (URI), Kronos Worldwide (KRO), and Dana Holdings (DAN). The full report and video can be found here: http://sabrient.com/individuals/Bakers-Dozen-2012-Signup.html
Notably, KRO is also a favorite of Sabrient subsidiary Gradient Analytics, which focuses on forensic accounting, earnings quality, and anomalous executive incentives activity. Although Gradient’s main focus is on identifying “at risk” stocks, the firm periodically publishes positive views on stocks having solid earnings quality coupled with bullish executive behavior—primarily in the form of exercise-and-hold options activity. In the case of KRO, Gradient observed a significant improvement in margins on higher sales prices. Also, the chairman continues to accumulate shares, and the firm appears to trade at a discount compared with its peers.
On the other end of the spectrum, several stocks having negative grades from Gradient continue to be weak even in the face of the bullish market, including TeleTech Holdings (TTEC), First Solar (FSLR), SodaStream International (SODA), Iconix Brand Group (ICON), Ritchie Bros Auctioneers (RBA), Accretive Health (AH), Diodes Inc. (DIOD), and Gentex (GNTX).
Looking at the charts, SPY closed Wednesday at 135.69. As I predicted, it made a false breakout above the 2011 highs last week, which served to pull in late-arriving bulls and led to a new 52-week high at 138.19 before reversing to fall as low as 134.26 on Tuesday. This weakness allowed the SPY to work off much of its overbought technical condition. Slow Stochastic has cycled back down to near oversold territory while RSI bounced at the neutral line. However, MACD is taking its time and looks like it is just getting started in its pullback, and Bollinger Bands are quite squeezed and need to spread themselves out again.
Notice in the chart that price has broken down through the near-term uptrend line that has been in place since late December, although it hasn’t quite reached the lower uptrend line that has been holding since early October. Despite the apparently eagerness of bulls to jump in now, I still expect a test of support at the longer term uptrend line sometime in the near future, which currently sits near 132. Perhaps Friday’s employment report will provide the catalyst.
For the past few weeks, I have talked about how the current rally that started at the beginning of October 2011 compares with the prior year’s rally that peaked around late February 2011. Now that we have reached the end of February 2012, we are getting something similar in the way of a pullback. We’ll see how far it goes…and whether the bulls can manage to hold the line this time around.
The VIX (CBOE Market Volatility Index—a.k.a. “fear gauge”) closed Wednesday at 19.07, after closing Tuesday above the important 20 threshold during Tuesday’s extreme weakness. The quick fall back below 20 reflects investor confidence and complacency. The TED spread (indicator of credit risk in the general economy, measuring the difference between the 3-month T-bill and 3-month LIBOR interest rates) closed Wednesday at 40 bps. It seems to have found a new home at these levels. The trend change from its highs near 60 reflects improving investor confidence—although it is still well above the teens we saw early last year.
Volume remains light, and I still believe that any real breakout attempt likely will need broader participation to get follow-through. There remains a lot of cash on the sidelines, and Wednesday’s strength seems to reflect an eagerness to buy any pullback.
Of course, it is the massive injections of liquidity from central banks around the world—led by the U.S. Federal Reserve—that has provided the fuel for this strength in stocks. All of the variations of quantitative easing have propped up the teetering banks and sovereign debt and by extension the global economy. It has also kept interest rates low, making it more attractive for businesses to borrow and invest. And much of this new money has been driven into stocks by rendering investment alternatives relatively undesirable.
On the flipside, however, fixed income investors have been undermined and pension plans have become dramatically underfunded. And the elephant in the room is the knowledge that eventually the balance sheets will have to be unwound. Such global deleveraging will surely curb spending and growth, putting a lid on the bull market. But that day may be a long ways off.
Latest rankings: The table ranks each of the ten U.S. industrial sector iShares (ETFs) by Sabrient’s proprietary Outlook Score, which employs a forward-looking, fundamentals-based, quantitative algorithm to create a bottom-up composite profile of the constituent stocks within the ETF. In addition, the table also shows Sabrient’s proprietary Bull Score and Bear Score for each ETF.
High Bull score indicates that stocks within the ETF have tended recently toward relative outperformance during particularly strong market periods, while a high Bear score indicates that stocks within the ETF have tended to hold up relatively well during particularly weak market periods. Bull and Bear are backward-looking indicators of recent sentiment trend.
As a group, these three scores can be quite helpful for positioning a portfolio for a given set of anticipated market conditions.
Observations:
1. Technology (IYW) remains at the top of the Outlook rankings with an 82. IYW is particularly strong in its return ratios as margins remain high in tech products. It is also relatively strong in its long-term growth rate and in analyst positive sentiment.
2. Financial (IYF) retains its hold on second place and crept up further to score a 72. Industrial (IYJ) and Healthcare (IYH) are in a tie for third at 53. Financial and Consumer Services (IYC) stocks are getting the most support from Wall Street analysts, but IYF is also maintaining a low (desirable) projected P/E ratio.
3. Telecom (IYZ) still dwells at the bottom of the rankings, but renewed analyst support has given it a more respectable score of 20 this week. IYZ remains saddled with the worst return ratios and one of the highest projected P/Es. It is again joined in the bottom two by Utilities (IDU) with a score of 22. IDU has poor long-term growth projections and relatively high projected P/E
4. Looking at the Bull scores, IYF has become the new leader on strong market days, scoring 53, followed by former leader IYM at 52. IYJ has fallen back to 50, these three are the only ones scoring 50 or above. Utilities (IDU) is by far the weakest on strong days, scoring 33.
5. Looking at the Bear scores, IDU is back as the investor favorite “safe haven” on weak market days, scoring 59, followed by IYH at 55. IYM shows by far the lowest Bear score of 39, as it has been slaughtered lately during market weakness. This means that Basic Materials stocks tend to sell off the most when the market is pulling back (which hadn’t been happening very often before Tuesday).
6. Overall, IYW still shows the best combination of Outlook/Bull/Bear scores. Adding up the three scores gives a total of 181. IDU is the worst at 112. IYF continues to strength across the board, and it now shows the best combination of Bull/Bear with a total score of 100. IYM and IYE now share the worst combination at 91. It wasn’t very long ago that IYE had the highest Bull/Bear combined score. Also notable is that IYJ and IYH are virtually identical in total scores, but they are nearly opposite on their Bull and Bear scores as one is clearly defensive and the other more aggressive.
Top ranked stocks in Technology and Financial include eResearch Technology (ERT), athenahealth, Inc. (ATHN), HFF Inc. (HF), and MarketAxess Holdings (MKTX).
These scores represent the view that the Technology and Financial sectors may be relatively undervalued overall, while Utilities and Telecom sectors may be relatively overvalued based on our 1-3 month forward look.
Disclosure: Author has no positions in stocks or ETFs mentioned.
About SectorCast: Rankings are based on Sabrient’s SectorCast model, which builds a composite profile of each equity ETF based on bottom-up scoring of the constituent stocks. The Outlook Score employs a fundamentals-based multi-factor approach considering forward valuation, earnings growth prospects, Wall Street analysts’ consensus revisions, accounting practices, and various return ratios. It has tested to be highly predictive for identifying the best (most undervalued) and worst (most overvalued) sectors, with a one-month forward look.
Bull Score and Bear Score are based on the price behavior of the underlying stocks on particularly strong and weak days during the prior 40 market days. They reflect investor sentiment toward the stocks (on a relative basis) as either aggressive plays or safe havens. So, a high Bull score indicates that stocks within the ETF have tended recently toward relative outperformance during particularly strong market periods, while a high Bear score indicates that stocks within the ETF have tended to hold up relatively well during particularly weak market periods.
Thus, ETFs with high Bull scores generally perform better when the market is hot, ETFs with high Bear scores generally perform better when the market is weak, and ETFs with high Outlook scores generally perform well over time in various market conditions.
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 ten iShares ETFs representing the major U.S. business sectors.
About Trading Strategies: There are various ways to trade these rankings. First, you might run a sector rotation strategy in which you buy long the top 2-4 ETFs from SectorCast-ETF, rebalancing either on a fixed schedule (e.g., monthly or quarterly) or when the rankings change significantly. Another alternative is to enhance a position in the SPDR Trust exchange-traded fund (SPY) depending upon your market bias. If you are bullish on the broad market, you can go long the SPY and enhance it with additional long positions in the 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 prefer not to bet on market direction, you could try a market-neutral, long/short trade—that is, go long (or buy call options on) the top-ranked ETFs and short (or buy put options on) 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.