Sector Detector: Rankings Get More Defensive
The market continues to confound trend riders. No sooner does a trend seem to take hold than it soon reverses. After the ugly "death cross" of the 50-day moving average down through the 200-day in early July, the two averages are converging once again. Post-Labor Day, somewhat surprisingly we are still in an ultra-low-volume trading environment, and the bulls have been able to hold support. However, it is quite easy for the big players to manipulate the markets when the volume is this low.
The bear flag that I described last week was confirmed last Monday—as was the head-and-shoulders top—when the support lines gave way, but then the market turned quickly in another double-bottom reversal (similar to early June) to take the SPY (SPDR Trust ETF, reflecting the S&P 500) from 105 back up to 111. With MACD now curling over, we might see a simple 50% retracement like we saw in early July. Or with the return of the senior portfolio managers and renewed volume, we might find that this was a false rally. I wouldn’t be betting on the start of a fall rally just yet—particularly given that September is historically the worst month for stocks.
The VIX volatility index is still range bound between 24 and 28, and the TED spread (i.e., indicator of credit risk measuring the difference between the 3-month T-bill and 3-month LIBOR interest rates) remains at the low end of its range, coming in today at 16.17, which is positive. And then, once again, there is the record levels of corporate cash that is starting to find its way into picking up strong, well-positioned, undervalued companies.
So, the market remains at a crossroads. The SPY and Russell 2000 small caps (IWM) are trapped between converging 50- and 200-day moving averages and awaiting the next breakout or breakdown, but the Dow Jones Industrials (DIA) and Nasdaq 100 (QQQQ) are above both averages. In fact, the QQQQ is looking like it’s in breakout mode and trying to lead the market higher. But one index does not make a total market, and SectorCast has gotten even more defensive this week.
Latest rankings: Sabrient’s SectorCast-ETF ranking of the ten U.S. business sectors has been reflecting a slightly bearish bias lately, and this week appears to be even more bearish. Other than the continued high ranking for Technology (IYW), which scored a robust 97, the current fundamentals-based quantitative rankings reflect a further cautious stance among analysts, which I have been reporting to be a moderately bearish sign for the markets.
The two biggest movers since last week are Healthcare (IYH), which increased from a score of 70 last week to 79 this week to remain in second place, and Energy (IYE), whose score dropped from 59 to 51. Most others scored about the same as last week.
IYW remains strong across the board, scoring highly (on a composite basis across its constituent stocks) in the percentage of analysts increasing earnings estimates as well as in return on equity, return on sales, and projected year-over-year change in earnings. IYH is strong in return on equity, return on sales, and projected P/E.
Top ranked stocks in IYW and IYH include RF Micro Devices (RFMD), Lexmark (LXK), Forest Labs (FRX), and Humana (HUM).
Over the past week, IDU was the weakest and IYJ the strongest. IYH lagged a bit, which likely helped it score a bit higher this week on valuation.
In examining the table, I see that seven of the ten ETFs are scoring 54 or lower. Furthermore, of the top three, two of them are traditionally defensive sectors in Healthcare and Consumer Goods, which tend to have relative inelasticity of demand. Only Technology continues to buck the trend by maintaining reasonable margins and enthusiasm among analysts. The fact that Energy has dropped further might be reflecting moribund projections for fuel demand, which would be indicative of a struggling economy.
At the bottom of the list, we continue to find Telecom (IYZ), with the highest PPE and poor return on equity. This week it scores a dismal 8. Joining it in the bottom two yet again is Consumer Services (IYC), scoring 16 primarily due to tight margins cutting into return on sales. It also scores poorly on the percentage of analysts increasing earnings estimates. Retailers and their Wall Street analysts remain gloomy about the near term outlook.
Low ranked stocks in IYZ and IYC include PAET Holding (PAET), Sprint Nextel (S), MGM Resorts International (MGM), and Gaylord Entertainment (GET).
These scores represent the view that the Technology and Healthcare sectors may be relatively undervalued overall, while Telecom and Consumer Services 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 model employs a fundamentals-based multi-factor approach considering forward valuation, earnings growth prospects, Wall Street analysts’ consensus revisions, accounting practices, 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 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.