Sector Detector: Leaders Solidify Their Positions

Healthcare, InfoTech, and Consumer Staples continue to lead in the Sector Detector ETF rankings, based on Sabrient’s fundamentals-based SectorCast model. Actually, they increased their scores this week relative to the other sectors as the bottom-up speculative rally led to further overvaluation in the fundamentally weaker sectors. 

SectorCast is quite predictive for identifying the best (most undervalued) and worst (most overvalued) sectors, with a 1-month forward look.

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 instance, 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, I use mostly Select Sector SPDRs, but because the SPDRs combine InfoTech and Telecom into one ETF, which Sabrient prefers to keep separate in accordance with S&P GICS classifications, I use the two iShares for those sectors. 

Latest rankings: This week, SectorCast-ETF is telling us that Healthcare (XLV) has further pulled away from the pack on a forward-looking basis, with the highest score of 93. It is followed by Information Technology (IYW) at 67. Top-ranked stocks within these sectors include Humana (NYSE: HUM), Coventry Health (NYSE: CVH), Seagate Technology (Nasdaq: STX), and IBM (NYSE: IBM).

Once again at the bottom we find Materials (XLB) with a low score of 30 and Consumer Discretionary (XLY) at 39. Low-ranked stocks within these sectors include Eastman Kodak (NYSE: EK), Marriott International (NYSE: MAR), Allegheny Technologies (NYSE: ATI), and U.S. Steel (NYSE: X). 

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 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, to further juice performance.

Performance Tracking: I’ll 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. 

Looking at our recent portfolios, the huge market up-move this past week resulted in the out-performance by the lower-ranked (fundamentally overvalued) sectors. After showing a nice gain last week, both the 10/27 and 11/3 long/short ETF portfolios underperformed a straight long position in the SPY. 

This can easily happen during moon-shot rallies, in which the more speculative names lead the market, but such extreme conditions rarely persist for long. 

I’ll continue to track the 10/27 portfolio for another 2 weeks, the 11/3 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.