Sector Detector: Healthcare ranking makes post-election surge

The resolution of uncertainty last week around the elections and FOMC announcement allowed the market to release some pent-up energy and finally break out of its consolidation pattern. After the normal head fakes in both directions, it rallied hard such that the S&P 500 reached a 2-year closing high. The Republicans took over leadership of the House, which will assuredly bring a measure of gridlock back to the political scene, and many market observers think the market prefers that. I said in last week’s column that I was expecting a significant market move one way or the other, and indeed we saw a nice little jump.

Although, the GOP victories were likely welcomed by the market, it is more likely the $600 billion QE2 that is bringing joy to Mudville. The Fed has stated that it will continue to do its part by pumping money into the system through "quantitative easing" (i.e., printing of money to buy back Treasuries from the primary dealers who then use the money to buy equities and commodities). Any other country would endure hyperinflation if they did such a thing, but the U.S. can get away with it because the global economy still depends on the American consumer and a healthy U.S. economy to thrive. The dollar has actually been strengthening since the FOMC announcement.

It continues to intrigue me how closely the chart pattern for the past 3 months is matching up to the 3-month timeframe at the beginning of the year that culminated in the May selloff. You can see in the chart that mid-January through mid-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 – just like its behavior in mid-April. Also take note of the 20-40 moving average lines. If history is to repeat, it should happen by early December.

The charts have been repeatedly flashing signs of an imminent trend change for the worse, but the macro story is somewhat different now than it was in April, and with the Fed’s support, the bulls just won’t let it happen. Every apparent start to the much-needed correction is quickly bought and turned into yet another head-fake that squeezes the shorts.

Although the charts are indicating that the next significant move will be down, we might not get the retest of resistance-turned-support at SPY 115 that I have been expecting. We might only get a minor break through the 20-day moving average to perhaps recent support at SPY 118.

After the close today, CSCO’s John Chambers tried to spoil the bull’s party with a cautious outlook. The stock is down –12.6% in afterhours trading and pulling down the market with it. Sabrient downgraded it from Strong Buy to Hold back in early June when it was losing its luster in our scoring system. Its Value, Growth, and Momentum scores are mediocre, and its Outlook Score (VCU) is on the low side (more info at http://Sabrient.com/individuals).

The market needs to pullback. Maybe this will finally get it going. Or if recent history is an indicator, it will have this afterhours pullback and then fly out of the gate in the morning with a huge bid.

The market volatility index (VIX) spiked early again today to as high as 19.96 (still historically on the low end), but once again stabilized and closed down at 18.47. It will most likely spike early again on Thursday with the CSCO impact, but we’ll have to see if it can stage another miraculous fall by the close. Also, 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 today at 16.39. Both VIX and TED remain low, reflecting a lack of fear.
 
Latest rankings:  Sabrient’s SectorCast-ETF fundamentals-based quantitative rankings of the ten U.S. business sector iShares had been in a holding pattern for a few weeks, with a neutral to slightly conservative bias. Analyst uncertainty in forward projections among sectors has been the main culprit.
 
However, this week brings a noticeable change. The score for Healthcare (IYH) has surged well past second place Technology (IYW) with a 90 compared with 75 for IYW, primarily due to a rash of analyst upgrades (likely tied to the election results and the impact on ObamaCare). Financials (IYF) keeps its hold on third place, but its score has dropped a bit to 68.

IYH continues strong in return on equity, return on sales, and projected P/E (low valuation). But it’s the surge to the top score in 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 IYW and IYH include Western Digital (WDC), Apple (AAPL), Forest Labs (FRX), and Humana (HUM).

Unfortunately for the bulls, Consumer Services (IYC) has continued to drop in the rankings to remain firmly in the bottom two with a score of 17, along with perennial cellar-dweller Telecommunications (IYZ), which scores 11 this week. Consumer Services are particularly sensitive to woes in the economy, so this is not a welcome sign. IYZ has by far the highest projected P/E and the worst return on equity. IYC is notably weak in return on sales as retail margins continue to be squeezed.

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.