Sector Detector: InfoTech rising
I’ve been reading prominent market pundits predicting everything from the “Crash of 2010 coming” to “Major surge ahead.” With such divergence of predictions, it seems like a good time to remain conservatively long/short in accordance with Sabrient’s SectorCast-ETF value-oriented model.
Although we are in a historically bullish time of year as we approach year end, the quantitative model doesn’t know that, and it’s telling us that all-weather sectors like Healthcare, Consumer Staples, and Utilities are preferable right now to Materials, Industrials, and Consumer Discretionary, which are more cyclical. Nevertheless, the re-emergence of InfoTech is a bullish sign, since no market rally is sustainable without leadership from the Technology sectors.
Latest rankings: As has become commonplace lately, Sector Detector tells us that Healthcare (XLV) still sports the best valuation with robust 87 score, and its lead over second place has broadened as Consumer Staples (XLP) has fallen back into a tie with Information Technology (IYW) with a score of 71. The high score for XLV is powered primarily by its low aggregate projected price to earnings ratio for the constituent stocks. It also benefits from a solid trailing 12-month return on equity. Although IYW and XLP are now tied, IYW has been rising while XLP has been dropping. 
So, I’m going to go with the momentum and select IYW for this week’s long/short portfolio. Top-ranked stocks within XLV and IYW include WellPoint (NYSE: WLP), Biogen Idec (Nasdaq: BIIB), Pitney Bowes (NYSE: PBI), and Tech Data (Nasdaq: TECD).
At the bottom of the rankings, we again find Materials (XLB) as the fundamentally most overvalued sector with a low score of 24. That’s actually down from 26 last week. It remains saddled with the highest aggregate projected P/E and negative trailing 12-month return ratios. Industrials (XLI) remains in ninth (of the 10 sectors) with a score of 39. It actually stole 2 points from XLB as it had a greater number of analyst upward earnings revisions among its constituent stocks this week.
No matter though—these two sectors are once again at the bottom of the SectorCast-ETF rankings. Low-ranked stocks within these sectors include Dow Chemical (NYSE: DOW), Vulcan Materials (NYSE: VMC), Textron (NYSE: TXT), and PACCAR (Nasdaq: PCAR).
These scores represent the view that Healthcare and Information Technology 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 portfolio as of the market close on Tuesday, 12/15/09. The top-ranked XLV continues to easily outperform the SPY in every portfolio. And shorting XLB has worked well—at least up until this past week, during which it rallied in step with the SPY. 
Overall, this continues to show how a sound absolute return approach can be 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.