Sector Detector: Materials Leads Bulls in Ensuring Strong First Quarter
Bulls continue to shake off global challenges to keep the market in rally mode heading into the end of the first quarter, led by powerhouse sectors Basic Materials and Energy as well as Healthcare and upstart Telecom. In fact, the S&P 500 is on track to achieve its largest first quarter return since 1998. The SPY closed today at 132.77, up 5.6% on the quarter with one more trading day to go.
However, trading volume remains weak, with NYSE volume failing to break 1.0 billion again, which observers say is due to caution in advance of the official nonfarm payrolls report on Friday.
Looking at the SPY chart, the pattern is now looking nearly identical to its pattern starting in early August.
The 50-day moving average provided no resistance during the early-September rally from that similar August pattern, and it provided little resistance this time, either, as it rallied right through it on Thursday and consolidated on Friday, retested it for resistance-turned-support on Monday, and continued rallying on Tuesday and Wednesday.
Like August, RSI is back above the neutral line and pointed up, and MACD is crossing over bullishly and pointed up. All systems are go – with the exception of the weak trading volume and overhead resistance at the February highs. There likely will be a test of bullish resolve after quarter-ending window dressing ends.
The TED spread (i.e., indicator of credit risk in the general economy, measuring the difference between the 3-month T-bill and 3-month LIBOR interest rates) is at 21.32, which is down from last week and still low in its normal range, although a good bit higher than it was in the September to February timeframe when it was sitting around 15. Fear as measured by the market volatility index (VIX) had briefly spiked above 31 the other week during the initial reports from Japan, but it has since come back down to close today at 17.71, which is below all of its moving averages. 
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.
The most notable changes in this week’s Sabrient’s SectorCast rankings are: 1) the fall of Technology (IYW) from 74 to 62 in its Outlook score, as Wall Street analysts are reining in their optimism a bit in earnings projections, 2) the rise in Telecom (IYZ) out of the bottom two for the first time in what seems like forever, 3) the rise in Industrial (IYJ) from seventh to fourth, which is bullish, and 4) only 3 of the 10 sector ETFs score above the 50 midpoint, which might be indicating the need for a near-term pullback. As I mentioned earlier, Telecom has been a leader in the recent stock market strength, which is reflected in its Outlook score as analysts have finally come around to upgrading their earnings projections.
Basic Materials (IYM) is back on top with an Outlook score of 78. Healthcare (IYH) is a close second with a 76. Technology (IYW) is the only other one above the midpoint of 50.
Telecom (IYZ) is out of the bottom two, leaving that indignity to Consumer Services (IYC) and Utilities (IDU) with Outlook scores of 25 and 30, respectively.
Looking at the Bull scores, Industrial (IYJ) and Basic Materials (IYM) have been the strongest during strong markets, followed by Energy (IYE) and Financial (IYF). IYJ has been climbing in this indicator of bullish sentiment. Utilities (IDU) continues to lag on strong market days.
As for the Bear scores, Utilities (IDU), which has the lowest Bull score, continues to be the favorite “safe haven” sector, followed closely by Consumer Goods (IYK), Energy (IYE), and Healthcare (IYH). Industrial (IYJ), which has the highest Bull score, has the lowest Bear score, reflecting quick abandonment by investors on weak market days.
Overall, Basic Materials (IYM) still displays the best combination of the three scores, while Energy (IYE) has the best combination of Bull/Bear. Energy (IYE) continues to be the only sector scoring above 50 on both Bull and Bear, reflecting positive investor sentiment in all market conditions. It seems that most all future economic conditions (short of global recession) are relatively favorable for Energy stocks.
Top ranked stocks in Basic Materials and Healthcare include OMNOVA Solutions (OMN), Puda Coal (PUDA), Forest Labs (FRX), and Humana (HUM).
Low ranked stocks in Consumer Services and Utilities include Barnes & Noble (BKS), MGM Resorts International (MGM), EnerNoc (ENOC), and Calpine (CPN).
These scores represent the view that the Basic Materials and Healthcare sectors may be relatively undervalued overall, while Consumer Services and Utilities 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 sectors.
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.