Sector Detector: Market gyrations fail to shake rankings

Last week I warned that after several attempts to pullback hard, the market's topping formation seemed to be kicking in. Indeed it did. After finding strong support around the 20-day moving average on those previous tests during April, last week investors fled rather than bid and the market actually bounced off its 200-day moving average during Friday’s session.

But Sabrient’s quantitative SectorCast-ETF rankings were impacted very little. The most obvious change is some relative strengthening in Energy. The model employs a fundamentals-based multi-factor approach including forward valuation, earnings growth prospects, recent analyst consensus sentiment, and various return ratios. Overall, the model still looks mostly bullish, with the more economically-sensitive sectors tending toward the top.

Latest rankings: The rankings are based on Friday’s close, so they don’t reflect Monday’s strong bounce from Friday’s abyss. But you can see that Energy (XLE) has jumped back into the top two this week. It saw strengthening in the number of analysts increasing earnings estimates, and it remains at the top in projected price/earnings ratio and near the top in projected year-over-year change in earnings.

Nevertheless, the top three sectors are bunched within a point of one another. Financials got bumped from first to third, but InfoTech (IYW) remains strong, taking the top spot with the same 69 score as last week. IYW continues to see more analysts increasing earnings estimates. Also, it is ranked highly in return on equity, return on sales, and projected year-over-year change in earnings.

Top-ranked stocks within IYW and XLE include Ingram Micro (NYSE: IM), Amkor Technology (Nasdaq: AMKR), Murphy Oil (NYSE: MUR), and ConocoPhillips (NYSE: COP).

As to the spread between the top and bottom sectors, it is holding at 34 this week. After being in the 65-point range a few months ago, it had recently tightened to only 22 points. I prefer to see wider top-bottom spreads to give me added confidence in the predictiveness of the rankings.

Telecommunications (IYZ) continues its firm hold on the bottom of the rankings. It is quite weak in its projected year-over-year change in earnings across the stocks in the sector, the net number of analysts increasing earnings estimates, and return on equity.

Also remaining in the bottom two this week is Consumer Staples (XLP). Although, as a defensive sector, it has held up relatively well on the big down days, its Outlook score fell somewhat again this week. It sports the best return on equity, but it is weak in all other metrics.

Low-ranked stocks within XLP and IYZ include General Mills (NYSE: GIS), Safeway (NYSE: SWY), Verizon (NYSE: VZ), and Leap Wireless (Nasdaq: LEAP).

These scores represent the view that InfoTech and Energy stocks may be relatively undervalued overall, while Telecom and Consumer Staples 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, 5/11/2010. Each portfolio assumes that the top two ETFs are entered long and the bottom two are entered short, all at the opening prices on Wednesday.Overall, performance is holding up much better than a straight long position on the market, as you would expect. Last week’s portfolio showed positive performance in a down market, with strength coming from our long in XLF and short in IYZ. Long positions in XLV and XLE in the 4/21 portfolio are still struggling against investor reluctance due to the ongoing Healthcare debate and the BP blowout in the Gulf of Mexico.

This long/short model seeks to profit whether the market goes up or down. Given the recent chaos in the market, it seems like a good bet to stick with such an absolute return approach.

Disclosure: Author has no positions in stocks or ETFs mentioned.

About SectorCast: The rankings are based on Sabrient’s SectorCast model, which builds a composite profile of each of the ten 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 one-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 eight 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 (2 longs and 2 shorts) 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.