Sector Detector: Consumer Staples leaps to top of rankings

As the stock market continues to trade at 15-month highs, Sabrient’s SectorCast-ETF model is getting even more defensive, even though we are in a historically bullish time of year. The fundamentals-based quantitative model has a GARP (growth at reasonable price) focus, and this week there are significant changes to the sector rankings.

The emergence of InfoTech earlier in the month was indeed a bullish sign, but the latest rankings might be indicating that a flight to quality is imminent.

Latest rankings: For the first time in a long time, Sector Detector is telling us that Healthcare (XLV) is no longer the strongest forward-looking sector. Although it still sports a strong score of 76, it is down from its 87 of the past couple of weeks. Supplanting it at the top is Consumer Staples (XLP), which leaped strongly to an 82 from last week’s 71 score. Last week’s second place sector was Utilities, and it now sits back in third with a score of 72. The high score for XLP is powered primarily by its top rank for the number of analyst upward earnings revisions among its constituent stocks this week and its strong return on equity rank. Healthcare still carries the lowest aggregate projected price to earnings ratio for its constituent stocks.

Top-ranked stocks within XLP and XLV include Dean Foods (NYSE: DF), ConAgra (NYSE: CAG), Cigna (NYSE: CI), and Forest Labs (NYSE: FRX).

At the bottom of the rankings, we again find Materials (XLB) as the fundamentally most overvalued sector with an improving score of 30 (up from 24 last week). It remains saddled with the highest aggregate projected P/E and negative trailing 12-month return ratios. Industrials (XLI) has risen somewhat and is no longer in ninth (of the 10 sectors). It has been replaced by Consumer Discretionary (XLY), which has weakened somewhat relative to Energy and Industrials, particularly with regard to the number of analyst upward earnings revisions among its constituent stocks, and now sports an overall score of 41.

Low-ranked stocks within these sectors include Alcoa (NYSE: AA), International Paper (NYSE: IP), Harley Davidson (NYSE: HOG), and Harman International (NYSE: HAR).

These scores represent the view that Consumer Staples and Healthcare stocks may be undervalued overall, while Materials and Consumer Discretionary stocks may be overvalued.

Performance: The table below shows the performance of each of the prior four weekly portfolio as of the market close on Tuesday, 12/29/09.  XLV has slowed its excellent outperformance somewhat, and shorting XLB has hurt. However, the 12/16 portfolio benefited greatly from strong performance by the IYW.

Although December performance has been lagging a bit, the absolute return approach is still highly desirable for positioning an ETF portfolio to survive and thrive in any market climate.

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.