Sector Detector: Healthcare and Technology Continue Strong in Rankings
This market sees nothing but rainbows and butterflies ahead. No worries, no fears. Although backing and filling is a necessary aspect of a healthy bull market, history shows that it can go on for awhile without. Now that the Dow has touched 12,000 and the S&P 500 came within a whisker of 1300, perhaps the bulls will be ready for a much-needed respite. In this overzealous market, Sabrient’s SectorCast ETF model continues to favor Healthcare and Technology.
You can see in the 10-year chart of SPY that it can stay on a steady bullish trend for quite some time, while the bearish periods are shorter and more explosive. The triple bottom in early 2003 launched a steady 4-1/2-year run that petered out with a double-top and then a cataclysmic fall concurrent with the financial crisis and real estate meltdown. Likewise, the V-bottom in March 2009 has turned out to be the start to quite a strong rally that is approaching 2 years in duration.
Still, as you can see, the RSI and MACD tend to at least revisit the neutral line periodically, even during raging bull runs.
The SPY was able to remain between the upper Bollinger Band and the 20-day moving average for 2-1/2 months during the September-to-mid-November timeframe. As shown in the second chart, the uptrend line is virtually a least-squares fit to the 20DMA. Also, there have been at least five bullish rising wedges since September 1, with the first four each leading to yet another bullish breakout. We’ll soon see what becomes of the fifth.
MACD has been flatlined near overbought since mid-December. It did the same for a couple of months in the mid-September to mid-November timeframe, before threatening to breakdown completely.
A pullback here would be healthy for a continued bull market. But because everyone is thinking the same thing, it might be quick and shallow, like we saw in November…if it happens at all.
The market volatility index (VIX) closed today at a low 16.65, and 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 at 15.22. Both indicators remain relatively low and still reflect complacency (and investor optimism). Also, the CBOE Put/Call Ratio closed yesterday at 0.65, which is up from the 0.37 reading it clocked in recently.
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 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.
As a group, these three scores can be quite helpful for positioning a portfolio for a given set of anticipated market conditions.
Healthcare (IYH) remains strong with a robust Outlook Score of 86. Technology (IYW) comes in second this week holding at 85. These two have consistently scored at the top as their performance hasn’t outrun reasonable valuation and analyst expectations.
Financial (IYF) and Basic Materials (IYM) jumped this week to third and fourth, although IYF is a distant third with a score of 57. Their surging scores pushed them past defensive sector Consumer Goods (IYK), as well as Energy (IYE), which fell 15 points this week from 54 to 39, due mainly to valuation after a strong run.
It is encouraging for bulls to see that five of the 10 sector ETFs are scoring above the 50 mid-point score. This reflects optimism among analysts.
Telecommunications (IYZ) of course shows up again in the cellar with a 15, as the U.S. Telecom companies just don’t show much in the way of compelling growth or projected valuations. Consumer Services (IYC), strengthened a bit this week, but couldn’t quite pull in front of the freefalling IYE. So, IYC again joins IYZ in the bottom two this week with a score of 38. Energy (IYE) continues to strengthen in the rankings.
Looking at the Bull and Bear scores, Basic Materials (IYM) and Industrial (IYJ) have tended to perform the best in recent periods of overall market strength, while not surprisingly Consumer Goods (IYK) and Utilities (IDU) have held up the best on weak market days. Overall, I would say that Technology (IYW) boasts the best combination of the three scores.
IYH continues strong in return on equity and return on sales, and it has by far the lowest (best) projected P/E, although its long-term growth rate is a bit suspect. IYW remains strong across most all factors in the quantitative model, 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 Healthcare and Technology include The Medicines Co. (MDCO), Forest Labs (FRX), LTX-Credence (LTXC), and Fairchild Semiconductor (FCS).
IYZ has by far the highest projected P/E and the worst return on equity. IYM has the lowest analyst rank as it was hit hard by a net increase in analysts reducing earnings estimates. IYC is notably weak in return on sales as retail margins continue to be squeezed despite improving consumer spending.
Low ranked stocks in Telecom and Consumer Services include American Tower (AMT), Terremark Worldwide (TMRK), Amazon.com (AMZN), and Six Flags Entertainment (SIX).
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 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.