Sector Detector: Rankings hold steady as market marches upward

As the market continues its slow but steady march further into overbought territory, Sabrient’s SectorCast-ETF rankings are holding steady. Energy, Healthcare and Financials still look undervalued, while Telecom, Industrials, and Materials look overvalued.

At year end, SectorCast was flashing warning signals about the market getting ahead of itself, and soon thereafter the market corrected. Then the model showed indications that the market wanted to breakout to the upside, which it has. Now, SectorCast seems to be reflecting the uncertainty among analysts by appearing to give a more neutral stance on near-term market direction.

With the S&P 500 sitting at a decision point around 1150, we’ll have to wait and see which way it decides to go. Consumer Discretionary has stalled its upward climb in our rankings, and InfoTech has stabilized its fall – both stopping in the middle of the. So, these two economically-sensitive sectors are not providing much in the way of clues regarding market direction.

Latest rankings: This week, the top and bottom sectors in SectorCast-ETF remain the same as last week. Energy (XLE) holds on to the top spot with a score of 76. Healthcare (XLV) continues in second place with a 71, again followed by Financials.

XLE boasts the top score in projected year-over-year change in earnings across the sector and also shows the best (lowest) projected price/earnings ratio. It also scores highly in the percentage of analysts’ positive revisions to earnings estimates.

 XLV ranks second in return on equity and third in projected P/E, but in general it achieves its overall ranking by simply scoring reasonably well across all of the relevant factors in the model.

Top-ranked stocks within XLE and XLV include Murphy Oil (NYSE: MUR), ConocoPhillips (NYSE: COP), Bristol-Meyers Squibb (NYSE: BMY), and Coventry Health Care (NYSE: CVH).

At the bottom of the rankings, we again find Telecommunications (IYZ) and Industrials (XLI). IYZ came in with a low score of 35, while XLI remains in the ninth spot with a score of 44. IYZ received even more analyst downgrades to earnings estimates during the week, is the worst in across the sector, and is near the bottom in return on equity. XLI still sports the worst (highest) projected P/E and the second-to-the-worst projected year-over-year change in earnings.

Low-ranked stocks within XLI and IYZ include C.H. Robinson Worldwide (Nasdaq: CHRW), Caterpillar (NYSE: CAT), Cbeyond, Inc. (Nasdaq: CBEY), and Global Crossing Ltd. (Nasdaq: GLBC).

Again, these scores represent the view that Energy and Healthcare stocks may be undervalued overall, while Telecom and Industrials 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, 3/16/2010.

As the market continues to rally (in fact, the SPY today set a 15-year-old record by going up for 13 consecutive days), long position XLF has shown extraordinary performance whil XLE has had a hard time getting traction. Keep in mind, Sabrient’s SectorCast model is fundamentals-based, including valuation and changes to analyst consensus opinions about stocks within a sector, and there are no momentum factors or technical triggers.

The -1.7% performance for the 2/17/10 portfolio is disappointing for a long/short portfolio, and it’s frustrating having to continue carrying forward the XLY as one of the prior short positions, given that XLY has risen so strongly in the quant rankings (concurrently with its strong technical performance). But keep in mind that it is rare to have excessive losses with a solid fundamentals-based ranking system like SectorCast …and our extensive backtesting of the model tells me that it shouldn’t go on like this much longer.

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

About SectorCast: The rankings are based on Sabrient’s SectorCast model, which builds a virtual profile of each of the 10 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 1-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 8 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 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.