Sector Detector: Telecom emerges

Last week's Sector Detector post debuted a new ranking system by Sabrient Systems that is calculated using fundamentals research on exchange-traded funds rather than the usual price momentum that most other indexes are based on.

However, the new SectorCast system encountered a data error on a single telecom stock that sent the entire sector score into the cellar. Instead, telecom should have been the strongest sector rather than the weakest.

The model has been adjusted so that such a data error won't create this situation again. We apologize for the error.

This week, the bug-free SectorCast is telling us that Telecom (IYZ) has the highest score of 87, followed by Consumer Staples (XLP) at 70. Top-ranked stocks within these sectors include Cincinnati Bell (CBB), NII Holdings (NIHD), Safeway (SWY), and Reynolds American (RAI).

Lurking at the bottom are Industrials (XLI) with a low score of 37 and Materials (XLB) at 42. Low-ranked stocks within these sectors include Textron (TXT), Monster Worldwide (MWW), Dow Chemical (DOW), and Vulcan Materials (VMC).

These scores represent the view that Telecom and Consumer Staples stocks may be undervalued, while Industrials and Materials stocks may be overvalued.

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 one more idea: You can trade some of the highest and lowest ranked stocks from within those top- and bottom-ranked ETFs to further juice performance.

I will track the given 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.

Looking at last week's portfolio (XLP/XLU long and XLB/IYZ short) after one week: XLP gained 2.1 percent, XLU rose 1.6 percent, XLB is up 1.4 percent, and IYZ fell 0.76 percent. Simply looking at these returns in dollar terms (assuming $1,000 per ETF position), a market-neutral long/short (with shorts margined against all-cash longs) would have gained $31 (1.55 percent). For comparison, putting $2,000 into the SPY would have gained $32 (1.6 percent).

Because of the data error in the telecom sector score, I won't track last week's portfolio any further. Rather, I will track today's portfolio (IYZ/XLP long and XLI/XLB short) for four weeks.

Disclosures: I have no positions in stocks or ETFs mentioned.