Sector Detector: Materials and Financials keep the New Year’s party rockin’
Stocks are maintaining their bullish sentiment for the New Year. The proverbial “wall of worry” remains high and intimidating, but bulls traditionally prefer it this way. It makes the less optimistic investors keep a store of cash, and it keeps the bears pumping money into short positions—both of which can provide fresh fuel for stocks when idle cash gets put to work and the bears start covering their shorts. When everyone is already on the bullish bandwagon, there is no source of fresh investment capital to keep the uptrend intact.
This week through Wednesday, the leading sector iShares were Basic Materials (IYM) and Financial (IYF), followed closely by Industrial (IYJ), while the laggards have been Energy (IYE) and Utilities (IDU). For the market to continue higher, it is going to need strength in the Financials, and we are definitely seeing it. Strength in Materials was at least partly attributed to an upbeat earnings report from Alcoa (AA) to kick off another hopeful earnings season.
Interestingly, while IYE was hit with a -1.3% loss on Wednesday due to weaker energy prices, solar names were up big on analyst speculation about new opportunities.
In fact, Trina Solar (TSL), JA Solar (JASO), and Jinko Solar (JKS) were each up over +30%! All of the solars display high Value scores in the Sabrient quant algorithms. JASO and GT Advanced Technologies (GTAT) also sport strong Growth scores.
Another possible reason for strength in U.S. stocks is weakness in Chinese equities, which has led to a flow of money from China and emerging markets into the relative safety of the U.S. Some analysts are even speculating that China might need to institute economic stimulus to get imports growing again, which would benefit sales growth of U.S. companies.
In case you missed it, Sabrient’s annual “Baker’s Dozen” Top 13 Stocks for 2012 were unveiled last week in a free live WebCast. Sabrient’s founder and chief market strategist David Brown was the main speaker, and Luke Rahbari of Stutland Volatility Group offered up his suggestions on how a trader might execute options trades on some of the names on the list. The video replay will be available for viewing any day now, but you can find the full list of 13 on the Sabrient web site:
http://www.sabrient.com/individuals/Bakers-Dozen-2012-Signup.html
SPY closed Wednesday at 129.20. Looking at its chart, it is holding its recent breakout above the symmetrical triangle formation and the tough 200-day simple moving average that had foiled the prior several breakout attempts. RSI, MACD, and Slow Stochastic are now all consolidating gains after turning up bullishly on the breakout. Daily trading volume remains low, however. We got the brief test of resistance-turned-support at the 200DMA last Thursday, as I suggested we might, and now SPY is testing the October highs—and likely has its sights set on its July highs.
The VIX (CBOE Market Volatility Index – a.k.a. “fear gauge”) closed Wednesday at 21.05, after bouncing off of support at the 20 level on Tuesday. This is the test of support I have been anticipating. Let’s see if it can make a run at breaking down through 20, which would be bullish for the market. In any case, VIX remains relatively low, especially compared with the high-volatility environment we have seen so much over the past year. Having it trading well below 30 indicates a lack of investor fear and a fertile climate for equity bulls.
The TED spread (indicator of credit risk in the general economy, measuring the difference between the 3-month T-bill and 3-month LIBOR interest rates) continues to be held back by resistance at the 60 level. Recall that it was in the low teens back in August. It closed at 56.63 on Wednesday. This indicates elevated investor worry about bank liquidity and a preference for the safety of Treasuries bonds over corporate bonds, but at least it has stopped its monotonic rise. Let’s see if the TED spread can start to pull back, or if it is merely consolidating for another run at resistance.
Latest rankings: The table ranks each of the ten U.S. industrial sector iShares (ETFs) by Sabrient’s proprietary Outlook Score, which employs a forward-looking, fundamentals-based, quantitative algorithm to create a bottom-up composite profile of the constituent stocks within the ETF. In addition, the table also shows Sabrient’s proprietary Bull Score and Bear Score for each ETF.
High Bull score indicates that stocks within the ETF have tended recently toward relative outperformance during particularly strong market periods, while a high Bear score indicates that stocks within the ETF have tended to hold up relatively well during particularly weak market periods. Bull and Bear are backward-looking indicators of recent sentiment trend.
As a group, these three scores can be quite helpful for positioning a portfolio for a given set of anticipated market conditions.
Observations:
1. Technology (IYW) remains in the top spot, coming in with an Outlook score of 81—still above the 80 mark, which I consider important for the top-ranked stock in order for the relative rankings to be predictive. (When the scores are bunched together at lower values, it indicates to me indecision and uncertainty about which sectors will be the leaders.) IYW is particularly strong in its return ratios and also sports a solid (low) projected P/E.
2. Healthcare (IYH) stays strong with a 78 this week to hold second place by a comfortable margin over Industrial (IYJ). IYH has stayed strong with the analysts’ sentiment, but it is held back somewhat by a relatively weak projected low-term earnings growth rate.
3. Energy (IYE) has fallen a few more points and now sits in seventh place below defensive sectors Consumer Goods (IYK) and Utilities (IDU). Although both IYE and Basic Materials (IYM) sport low projected P/Es and the highest projected long-term growth rates, apparently investors still think the analysts are too optimistic, even with the ongoing downward earnings revisions. The fact that IYE and IYM are both ranked so low might reflect a perception that the dollar will continue to strengthen against the euro.
4. Utilities (IDU) holds onto sixth place on the strength of the highest “net revisors” score, i.e., analysts are not cutting earnings estimates like they have in the other sectors. By the way, IYJ has the second highest net revisors score, which is a strong positive for the market in my eyes.
5. Telecom (IYZ) holds its position ahead of Consumer Services (IYC), but these two still dwell at the bottom of the rankings, and in fact their scores are lower this week by several points as stocks in both sectors got hit with analyst downward revisions. IYZ remains saddled with the highest projected P/E, while IYC is burdened by tight margins and low return on sales.
6. Looking at the Bull scores, IYM has been the leader on strong market days, scoring 61, followed by Financial (IYF). IDU is by far the weakest on strong days, scoring a 33.
7. As for the Bear scores, IDU is the investor favorite “safe haven” on weak market days with a score of 66, followed closely by IYK and IYH. IWM, the strongest on bullish days, displays by far the lowest Bear score of 38, which means that stocks within this ETF sell off the most on weak market days. Interestingly, only three of the sector iShares (IYM, IYF, and IYE) have Bear scores below 50.
8. Overall, IYH now displays the best combination of Outlook/Bull/Bear scores. Adding up the three scores gives a total score of 184, slightly ahead of IYW’s 183. IYC is the worst at 115. IYJ now has the best combination of Bull/Bear with a total score of 108, while IYM, IDU and IYC all share the worst combination at 99.
The emergence of IYJ in both its fundamental Outlook score and in its combination of sentiment-oriented Bull and Bear scores is a bullish development for the market overall. On the other hand, the fact that only 3 of the 10 sector ETFs score above the 50 midpoint is less encouraging.Top ranked stocks in Technology and Healthcare include Seagate Technology (STX), Silicon Motion Technology (SIMO), Jazz Pharmaceuticals (JAZZ), and United Therapeutics (UTHR).These scores represent the view that the Technology and Healthcare sectors may be relatively undervalued overall, while Consumer Services and Telecom sectors may be relatively overvalued based on our 1-3 month forward look.
Disclosure: Author has no positions in stocks or ETFs mentioned.
About SectorCast: Rankings are based on Sabrient’s SectorCast model, which builds a composite profile of each equity ETF based on bottom-up scoring of the constituent stocks. The Outlook Score employs a fundamentals-based multi-factor approach considering forward valuation, earnings growth prospects, Wall Street analysts’ consensus revisions, accounting practices, and various return ratios. It has tested to be highly predictive for identifying the best (most undervalued) and worst (most overvalued) sectors, with a one-month forward look.
Bull Score and Bear Score are based on the price behavior of the underlying stocks on particularly strong and weak days during the prior 40 market days. They reflect investor sentiment toward the stocks (on a relative basis) as either aggressive plays or safe havens. So, a high Bull score indicates that stocks within the ETF have tended recently toward relative outperformance during particularly strong market periods, while a high Bear score indicates that stocks within the ETF have tended to hold up relatively well during particularly weak market periods.
Thus, ETFs with high Bull scores generally perform better when the market is hot, ETFs with high Bear scores generally perform better when the market is weak, and ETFs with high Outlook scores generally perform well over time in various market conditions.
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 ten iShares ETFs representing the major U.S. business sector.
About Trading Strategies: There are various ways to trade these rankings. First, you might run a sector rotation strategy in which you buy long the top 2-4 ETFs from SectorCast-ETF, rebalancing either on a fixed schedule (e.g., monthly or quarterly) or when the rankings change significantly. Another alternative is to enhance a position in the SPDR Trust exchange-traded fund (SPY) depending upon your market bias. If you are bullish on the broad market, you can go long the SPY and enhance it with additional long positions in the 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 prefer not to bet on market direction, you could try a market-neutral, long/short trade—that is, go long (or buy call options on) the top-ranked ETFs and short (or buy put options on) 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.