Sector Detector: Rankings positioned to weather a pullback

The market is finally giving us the long anticipated and overdue pullback. This is good for its longer term health. The media is attributing the weakness to news out of Ireland, but the fact is that the technical picture has been screaming for a pullback and retest of key support levels, including Dow 11,000. If the S&P500 violates its 50-day moving average around 1165, the next test will be minor support around 1160, then resistance-turned-support at 1150, and finally the 200-day moving average, which current sits near 1128. The SPX closed today at 1178, after reaching as high as 1227 on November 5.

I’ll continue my ongoing saga about how closely the chart pattern for the past almost 4 months is matching up to the similar timeframe at the beginning of the year that culminated in the May selloff. January through April produced a very similar Price and MACD pattern to what we have seen since early August. After a sustained bullish run coming off a bottom at SPY 105, both periods came to a multi-week price consolidation zone with a lengthy period of overbought MACD, followed by another brief surge and consolidation.

The current MACD tried once to crossover bearishly, and is now trying again and seemingly finding success this time. Today’s dark candlestick looks very much like the one on May 4. On that day, it bounced at the 50-day moving average, and was then followed by the flash-crash on May 6 that took it all the way down to 105 intraday. Today’s action didn’t quite get down to the 50DMA, but it was close.

I have been showing the 20-40 moving average lines, which have lined up identically to the earlier period, but today I’m showing the longer-term 50-100 MAs. Nevertheless, they are lining up over the past few weeks, and an imminent rollover is indicated. If history is to repeat, it should happen real soon.

Last week, I suggested that we might not get that retest of resistance-turned-support at SPY 115, and instead only get a minor break through the 20-day moving average to perhaps previous support at SPY 118. We bounced there today. Let’s see if the bulls – with their friend the Fed pumping big-time cash into the system – can regain control.

The dollar has actually been steadily strengthening since bouncing at multi-year support following the November 3 FOMC announcement. The market doesn’t particularly want a stronger dollar, though.

Not surprisingly, the market volatility index (VIX) spiked at the open today and kept on rising, finishing at 22.58 as some of the complacency evaporated. On the other hand, the TED spread (i.e., indicator of credit risk measuring the difference between the 3-month T-bill and 3-month LIBOR interest rates) is still comfortably at the low end of its range, closing down significantly today at 14.75.

Latest rankings:  After being in a holding pattern due primarily to Wall Street analyst uncertainty in anticipation of the election, Sabrient’s SectorCast-ETF fundamentals-based quantitative rankings of the ten U.S. business sector iShares took a noticeable change last week. Healthcare (IYH) distanced itself from the others, primarily due to a rash of analyst upgrades (likely tied to the election results and the impact on ObamaCare).

Overall, the rankings reflect a cautious bias on the market, as traditionally defensive sectors like Healthcare, Consumer Goods and Utilities continue to show up in the top 5 with scores above 50, and the more economically-sensitive sectors like Energy, Industrial, and Consumer Services rank in the bottom 5 with scores below 50.

This week, the rankings are holding steady, with Healthcare (IYH) scoring an 89, followed by Technology (IYW) at 77, and Financial (IYF) at 65. IYH continues strong in return on equity, return on sales, projected P/E (low valuation), and analysts increasing earnings estimates that really drove its dominant ranking. IYW remains pretty strong across the board, too, scoring highly (on a composite basis across its constituent stocks) in return on equity, return on sales, projected P/E, projected year-over-year change in earnings, and analysts increasing earnings estimates.

Top ranked stocks in Healthcare and Technology include Eli Lilly (LLY), Humana (HUM), Arrow Electronics (ARW), Flextronics (FLEX).

Telecommunications (IYZ) remains in the cellar with a score of 12, and Consumer Services (IYC) remains in the bottom two, but its score strengthened a tad to 22 (from 17 last week) due to some analysts coming out to increase earnings on some of the stocks in the sector. Nevertheless, Consumer Services stocks are particularly sensitive to woes in the economy, and margin continue to be squeezed, impacting return on sales. IYZ has by far the highest projected P/E and the worst return on equity.

Low ranked stocks in IYZ and IYC include Sprint Nextel (S), SBA Communications (SBAC), MGM Resorts International (MGM), and Amazon.com (AMZN).

These scores represent the view that the Healthcare and Technology 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.