Sector Detector: Healthcare Leads the Way

Sabrient’s fundamentals-based ETF rankings, based on our new and powerful SectorCast model, has proven to be quite predictive for identifying the best (most undervalued) and worst (most overvalued) sectors, with a 1-month forward look. This week, Healthcare continues to lead by a healthy margin.

 
Of course, each ETF is unique, so the sectors represented will score differently depending upon which set of ETFs are used. For example, iShares follows the Dow Jones sector indices, while Select Sector SPDRs follows those stocks from the S&P 500 that are in the given sector. Although both use market-cap weighting, sometimes they can be quite different. For example, Monsanto (NYSE: MON) represents 15% of the Materials SPDR (XLB), but it’s not even a constituent of the iShares Basic Materials (IYM)—instead it’s in the iShares Consumer Goods ETF (IYK) where it makes up less than 4% of the portfolio. 
 
So, Sabrient’s sector rankings may vary depending upon what baskets of stocks are being ranked. For Sector Detector, which employs our SectorCast model that references the S&P GICS classification system, I use mostly Select Sector SPDRs. But Sector SPDRs combines InfoTech and Telecom into one ETF (XLK), while Sabrient prefers to keep them separate, so I use the two iShares for those sectors. 
 
Latest rankings: This week, Sector Detector is telling us that Healthcare (XLV) has the highest score of 87, followed by Information Technology (IYW) at 64. Top-ranked stocks within these sectors include Wellpoint (NYSE: WLP), IMS Health (NYSE: RX), Corning (NYSE: GLW), and Synaptics (Nasdaq: SYNA). 
 
Firmly at the bottom are Materials (XLB) with a low score of 33 and Consumer Discretionary (XLY) at 38. Low-ranked stocks within these sectors include Abercrombie & Fitch (NYSE: ANF), Marriott International (NYSE: MAR), Allegheny Technologies (NYSE: ATI), and Vulcan Materials (NYSE: VMC). 
 
These scores represent the view that Healthcare and InfoTech stocks may be undervalued, while Consumer Discretionary and Materials stocks may be overvalued.
  
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 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, to further juice performance.
 
Performance Tracking: I’ll track the given set of ETFs as a mini-portfolio each week 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.
 
Looking at last week’s portfolio (XLV/XLP long and XLY/XLB short) after one week: XLV was down -1.12%, XLP was up +0.08%, XLY was down -1.81%, and XLB was down -1.94%. Simply looking at these returns in dollar terms (assuming $1,000 per ETF position), a market-neutral long/short (with shorts margined against $2,000 all-cash longs) would have gained $27 (+1.35%).
 
For comparison, putting $2,000 into the SPY would have lost $33 (-1.66%). Again, this illustrates the benefit of an absolute return long/short strategy that has the potential to make money in any market.
 
I’ll continue to track that portfolio for the next 3 weeks, as well as today’s portfolio (XLV/IYW long and XLY/XLB short) for the next 4 weeks.
 
Disclosure: Author has no positions in stocks or ETFs mentioned.