Sector Detector: Healthcare reigns
Despite its value orientation making it take a relatively defensive posture, Sabrient’s fundamentals-based SectorCast-ETF model has been performing well even as the market continues to hit new highs. This is because leadership has swung to traditionally defensive sectors like Healthcare, which continues to score at the top of the rankings while also showing strong momentum. With the Massachusetts election victory of Republican Scott Brown putting in doubt the Obama administration’s healthcare plan, I’m eager to see how healthcare stocks react.
Latest rankings: SectorCast is designed to take a one-month forward look, and this week shows almost no change in the relative scoring. Healthcare (XLV) comes back this week to reign supreme with the same high score of 80, and Utilities (XLU) stays in second place with a score of 75. Their leading scores are powered primarily by their low aggregate projected price to earnings ratio. Return ratios are also strong—particularly return on equity for XLV and return on sales for XLU. 
In the middle of the pack, InfoTech (IYW) strengthened while Telecom (IYZ) weakened, due to the number of analyst upward earnings revisions among their constituent stocks during the week.
Top-ranked stocks within XLP and XLV include Merck (NYSE: MRK), Humana (NYSE: HUM), American Electric Power (NYSE: AEP), and Edison International (NYSE: EIX).
At the bottom of the rankings, we find the usual suspects of Materials (XLB) and Industrials (XLI). XLB continues as the fundamentally most overvalued sector with a low score of 30, and now its technical strength has waned as the dollar has stabilized. There is no change in its relatively high aggregate projected P/E and poor return ratios—both return on equity and return on sales. XLI came in this week with a score of 39. It remains hampered by a poor projected change in year-over-year earnings across the sector.
Low-ranked stocks within these sectors include Alcoa (NYSE: AA), Vulcan Materials (NYSE: VMC), PACCAR (Nasdaq: PCAR), and Monster Worldwide (NYSE: MWW).
These scores represent the view that Healthcare and Utilities stocks may be undervalued overall, while Materials and Industrials stocks 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, 1/19/10.
The cooling of Materials as the dollar has stabilized, while Healthcare continues to forge ahead, has allowed the model portfolio performance to shine once again. Sector Detector has demonstrated that an absolute return approach is effective in positioning an ETF portfolio to survive and thrive in any market climate.
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.