Sector Detector: Renewed worries about the same old topics
Financials, Materials, Industrials, and Energy led the market to the downside on Wednesday after the Fed disappointed investors in their policy statement. In fact, investors were downright spooked, and the market fell about 2% in the last hour of trading alone. David Brown, founder and Chief Market Strategist here at Sabrient, told me that he can’t recall ever hearing such a negative statement on the economy from the FOMC. More weakness is likely for stocks.
After optimism abounded last week as nations around the world vowed to work together to save Europe, this week the Fed brought us back to reality by saying the economy has "significant downside risks,” including volatility in financial markets, high unemployment, depressed housing market, and cautious consumer spending. Plus, the IMF said that the global financial system is in its most vulnerable state since the 2008 financial crisis. The big “planning meeting” is taking place between finance ministers and central bank governors of the BRICS nations to address the European debt crisis. With the Greece 1-year bond yielding 134%, things could hardly be more urgent.
In an attempt to offer new stimulus to our economy, the FOMC announced its so-called “Operation Twist,” whereby they sell $400 billion in shorter-term Treasuries while purchasing an offsetting amount of longer-term Treasuries by the end of June 2012.
The move is intended to drive down interest rates on long-term government debt and trickle down to mortgages and other loans. But with the 10-year Treasury yielding only 1.90%, you have to wonder how much impact it can make.
Financials were hurt on Wednesday when Moody’s cut its debt ratings on Bank of America (BAC), Wells Fargo (WFC), and Citigroup (C), and the sector sold off hard in the final hour of trading. Notably, Tech stocks held up the best on Wednesday (and for the week so far, along with Utilities), as positive quarterly reports, favorable news, and analyst upgrades for stocks like Oracle (ORCL), Adobe (ADBE), Autodesk (ADSK), and Hewlett-Packard (HPQ) kept them in the green.
I have noticed that gold mining stocks have badly lagged the price run-up in gold bullion. I read an analysis of why this might be happening, citing high energy prices to produce it, high taxation, the threat of nationalization or confiscation in certain countries, and perhaps most importantly, the belief among equity investors that the price of gold price has reached an artificially and unsustainably high level. But at these lofty levels it continues to sit as global financial troubles abound, resulting in cash flow multiples trading at historic lows. Moreover, the ratio of price to net asset value of gold stocks is about where base metal stocks trade, which is highly unusual. But lately it appears there has been an attempt to close the gap, with money flowing out of the gold bullion ETFs like SPDR Gold Trust (GLD) and flowing into the Gold Miners ETFs like Market Vectors Gold Miners ETF (GDX).
Looking at the SPY chart, the channel between support at 112 and resistance at 121 got an upside resolution in late August, but then it turned into a false breakout with the early-September swoon. After rallying nicely back to the top of the channel, weakness set in yet again, but it stayed inside the channel. Last week's rally closed at 121.52, suggesting another try at a breakout, but progress this week has been difficult, and Wednesday finished poorly, producing an ugly red candle. Bollinger Bands have pinched back together and appear ready to break wider. With price hitting resistance at the 50-day simple moving average, and with RSI, MACD, and Slow Stochastic all pointing down, we’ll see if either the ascending triangle formation or the horizontal channel will be able to offer support.
The VIX (CBOE Market Volatility Index – a.k.a. "fear gauge") remains comfortably in the mid-30s and closed Wednesday at 37.32 – up +13.5% on the day. This is quite a bit higher than the teens it fluctuated in just months ago and reflects investor uncertainty.
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 creep higher. It closed today at 35.05. Although not nearly so high as it was during the financial crisis, it nevertheless indicates elevated investor worry about bank liquidity and a preference for the safety of Treasuries bonds over corporate bonds.
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.
Here are some observations about Sabrient’s latest SectorCast scores.
1. Healthcare (IYH) remains on top with a consistently improving Outlook score of 87. Healthcare is a growth sector within an aging population, no matter what the overall economy does. It has managed to maintain analyst support (on a relative basis) while other sectors are getting net reductions in earnings projections across the board. In fact, all sectors except Utilities were decidedly negative on net revisors this week, but IYH was about flat (equal number of downgrades as upgrades).
2. Energy (IYE) returns to the second spot with an Outlook score of 71 as analysts have been relatively easy on the sector’s earnings projections. It has reasonably good scores on most of the model’s factors and one of the lowest (best) projected P/Es.
3. The relative strength in net revisors allowed Utilities (IDU) and Telecom (IYZ) to rise from the bottom three for first time in a long time, as they now score a 39 and 30, respectively. Consumer Services (IYC) and Industrial (IYJ) are now at the bottom. IYC is still held back by the worst return on sales (poor margins). Industrial got hit hard (along with Materials) by downward analyst earnings revisions.
4. Overall, the Outlook rankings are now decidedly conservative, as Industrial and Consumer Services dwell at the bottom while Healthcare holds the top spot.
5. Looking at the Bull scores, Financial (IYF) has been the leader on strong market days, scoring 58, followed by Industrial and Basic Materials. Utilities is the weakest with a 44.
6. As for the Bear scores, Utilities is the clear investor favorite “safe haven” on weak market days with a score of 67. Consumer Goods and Healthcare are distant seconds at 59. Financial has the lowest Bear score of 42, as it leads the market up on strong days and down on weak days.
Overall, Healthcare (IYH) displays the best combination of Outlook/Bull/Bear scores. Adding up the three scores gives it a total score of 193. Utilities (IDU) has the best combination of Bull/Bear with a total score of 111. Both of these are defensive signs.
Top ranked stocks in Healthcare and Energy include Jazz Pharmaceuticals (JAZZ), UnitedHealth Group (UNH), CVR Energy (CVI), and Chevron Corp. (CVX).
Low ranked stocks in Consumer Services and Industrial include Six Flags Entertainment (SIX), Sears Holdings (SHLD), Apogee Enterprises (APOG), and FLIR Systems (FLIR).
These scores represent the view that the Healthcare and Energy sectors may be relatively undervalued overall, while Consumer Services and Industrial 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.