Sector Detector: Tech and Healthcare Still Reign Supreme

The SPY sold off early today in advance of the FOMC decision, but bounced strongly from the support line of the bearish rising wedge formation, which also is quite close to its 200-day moving average. Just as I said last week, all market indexes appear a bit extended and ready to pullback, but the bulls are game. Put/call ratio and volume is low. In fact, Monday saw extraordinarily low volume for a full (non-abbreviated) trading day.

Overall, the market’s resiliency remains intact, and all major indexes remain above their important 50-day and 200-day moving average. Although many technical indicators appear to be rolling over, that hasn’t phased this market lately.

Market volatility represented by the VIX spiked about 10% early in today’s session and then settled back down near the lows of the day – as it has tended to do often since peaking around 28 in mid-July. It closed today at 22.37, which along with the low put/call ratio certainly doesn’t reflect much fear among traders. Keep in mind that the VIX tends to move opposite the market, so finding a support level (like it seems to be doing lately in the 22 range) is typically bearish for the market – although it’s not an indicator that you can time the market on.

Sabrient’s SectorCast-ETF model employs a fundamentals-based multi-factor approach including forward valuation, earnings growth prospects, recent analyst consensus sentiment, and various return ratios. Other than the high ranking for Tech, current quant rankings are starting to reflect a more neutral stance among analysts.

Latest rankings: This week, Technology (IYW) remains the highest ranked ETF with a strong score of 83. IYW fares the best (on a composite basis across its constituent stocks) in the percentage of analysts increasing earnings estimates, and it ranks high in return on equity, return on sales, and projected year-over-year change in earnings. The second place spot goes to Healthcare (IYH) with a score of 76 – down from last week’s 81. It is strong in return on equity, return on sales, and projected P/E. The gap between second and third place is still pretty wide, as Energy (IYE) moves up into third with a 57.

Top ranked stocks in IYW and IYH include Ingram Micro (IM), TriQuint Semiconductor (TQNT), Forest Labs (FRX), and Endo Pharmaceuticals (ENDP).

Telecom (IYZ), having the highest PPE, now comes in dead last as it did under the previous SectorCast model, sporting a dismal score of 1. Joining it in the bottom two is Consumer Services (IYC), scoring a 23 primarily due to tight margins cutting into return on sales.

Low ranked stocks in IYZ and IYC include Crown Castle International (CCI), PAETEC Holding (PAET), Gaylord Entertainment (GET), and GSI Commerce (GSIC).

Again, the model is looking more neutral than bullish. These sector scores represent the view that the Technology and Healthcare 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: The rankings are based on Sabrient’s SectorCast model, which builds a composite profile of each of the ten ETFs 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 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 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.