Sector Detector: Financials and Energy top the rankings

Well, I’ve been writing in this column that the market has been signaling that it wants to breakout to the upside, and it finally broke back above its 50-day moving average as we began the new month. Sabrient’s SectorCast-ETF rankings are mostly holding steady, with Financials, Energy, Healthcare, and InfoTech still showing the best fundamental valuations.

Even the Outlook score for Consumer Discretionary is slowing creeping up, which further adds to the slightly bullish sentiment reflected by our unbiased, value-oriented, quantitative model. Overall, those sectors that are typically more dependent on economic growth continue to score better in our 1-month forward look than the more defensive sectors like Utilities, Consumer Staples, and Telecom.

The numbers seem to indicate increased corporate spending in advance of improving consumer spending later in the year, which would be quite positive. The increased weakness in the Outlook score for Industrials is perhaps the main cautionary sign.

Latest rankings: Once again, the top four sectors in SectorCast-ETF remain the same as the last few weeks…and they remain closely bunched within 5 points of one another. Financials (XLF) leads with a score of 74 (out of 100), followed closely in the rankings by Energy (XLE) at 73.

XLF still boasts the top score in projected year-over-year change in earnings across the sector, as well as the second best projected price/earnings ratio. XLE continues to display the best (lowest) projected P/E and a strong projected year-over-year change in earnings.

However, XLF still ranks last in trailing return on equity, while XLE ranks last in trailing return on sales. 

Top-ranked stocks within XLF and XLE include Torchmark (NYSE: TMK), Hudson City Bancorp (Nasdaq: HCBK), ConocoPhillips (NYSE: COP), and Consol Energy (NYSE: CNX). 

At the bottom of the rankings, we no longer find Telecommunications. Instead that indignity is assigned to Industrials (XLI) with a score of 35, which comes as a bit of a surprise to me. Although XLI now sports the worst (highest) aggregate projected price/earnings ratio, its raw score hasn’t fallen by much. It’s tumbled to the bottom mainly because we’ve seen more improvement in scores for Consumer Discretionary and Telecom. Despite improvements, the second most fundamentally overvalued sector is Telecommunications (IYZ) with a score of 41, which is up significantly from last week’s 23 due primarily to fewer analyst downgrades to earnings estimates. 

Notably, the Outlook score for Consumer Discretionary (XLY) continues to rise, and it now scores a mid-level 45, which is a positive indicator for continued market strength.

Low-ranked stocks within XLI and IYZ include C.H. Robinson Worldwide (Nasdaq: CHRW), Monster Worldwide (NYSE: MWW), Alaska Communications Systems Group (Nasdaq: ALSK), and Sprint Nextel Corp. (NYSE: S).

These scores represent the view that Financials and Energy stocks may be undervalued overall, while Telecom and Industrials stocks still may be overvalued.

Performance: The table below shows the performance of each of the prior four weekly portfolios as of the market close on Tuesday, 3/2/2010.

When the market rallies, it can be hard to compare a long/short ETF strategy against a straight long position in the SPY, since we are only seeking to capture the positive performance spread between the long and short positions. Nevetheless, with an absolute return approach, you prefer not to see significant downside. The -1.0% for the 2/10/10 portfolio is a bit bothersome, but keep in mind that it is rare to get much worse than this with a solid fundamentals-based ranking system like SectorCast…and it rarely lasts for long.

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.