Sector Detector: Healthcare Remains Firmly on Top

We are seeing only slight movement to Sabrient’s Sector Detector ETF rankings, as Healthcare, InfoTech, and Consumer Staples continue to lead, while Materials sinks further into the cellar and remains the fundamentally most overvalued sector. 

Latest rankings: This week, SectorCast-ETF indicates that Healthcare (XLV) remains solidly in front on a forward-looking basis, with the highest score of 93.

It is again followed by Information Technology (IYW) at 67. (Although Consumer Staples has moved up 1 point to tie InfoTech, we’ll stick with InfoTech for this week.) Top-ranked stocks within these sectors include WellPoint (NYSE: WLP), Cigna (NYSE: CI), STEC Inc. (Nasdaq: STEC), and Corning (NYSE: GLW).

At the bottom, we see that the score for Materials (XLB) has sunk even further, and it remains firmly in the 10th spot with a low score of 28. Industrials (XLI) is back in ninth at 42. Low-ranked stocks within these sectors include Alcoa (NYSE: AA), Weyerhaeuser (NYSE: WY), Monster Worldwide (NYSE: MWW), and PACCAR (Nasdaq: PCAR),

These scores represent the view that Healthcare and InfoTech stocks may be undervalued, while Materials and Industrials stocks may be overvalued.

Performance: Looking at our recent portfolios, the top-ranked ETFs have nicely outperformed the SPY, so a bullish-biased enhancement strategy has worked well.

However, the continued strong market momentum this month has resulted in even greater out-performance by the lower-ranked (fundamentally overvalued) sectors. So, all three long/short ETF portfolios have underperformed a straight long position in the SPY. This can happen during momentum rallies like we are seeing this month, in which the more speculative names lead the market.

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.