Sector Detector: Bulls sucking wind in late push to close year positive
Bulls are trying mightily to ensure the Santa rally holds into year-end and close the year in the positive, as all eyes remain on Europe. Although the European Central Bank (ECB) has refused to enact a U.S.-style “quantitative easing” by aggressively buying bonds to keep rates down, it has instead come through with an alternative solution—a bigger than expected refinancing operation in which it offers $645 billion in 3-year loans at 1% interest to struggling European banks. The hope is that the banks will reinvest in higher yielding bonds of the struggling euro-zone countries (i.e., “carry trade”). Such demand would keep rates on the sovereign debt manageable.
But it remains to be seen if the carry trade actually will occur. After all, these are not "risk-free" bonds as U.S. Treasuries are assumed to be. So far, European stocks have remained near their lows.
Here in the U.S., however, stocks have been trying to rally. On its sixth attempt since late-October, the S&P 500 on Friday finally made a bullish breakout above the tough resistance of its important 200-day simple moving average. The market appeared ready to rock & roll through year-end and into early-January. However, Wednesday brought hesitation, and the bears took the opportunity to push the S&P 500 back below the 200DMA.
Now the S&P 500 is struggling to finish the year in the positive. As of Wednesday’s close, it was just below 1250 after closing 2010 at 1258. It has two trading days left to get it done.
Among the ten U.S. sector iShares, the past few days have been a microcosm of the entire year, with Utilities (IDU) the strongest and Basic Materials (IYM) the weakest. For the year, IDU is up nearly +15%, followed by Healthcare (IYH), while IYM is down about -18%, followed closely by Financial (IYF).
Now let's look at the charts. The SPY closed Wednesday at 124.83, which is virtually the same level as last Wednesday. Referring back to the symmetrical triangle formation on the chart, we can see that support held at the convergence of the lower support line of the triangle and the 100-day simple moving average, and then this week resistance held at the convergence of the upper resistance line of the triangle and the 200-day simple moving average—leaving price back inside the triangle. Although RSI, MACD, and Slow Stochastic are all pointing down bearishly, this week’s trading has seen particularly low-volume typical of the holiday week, and I expect bulls will get together enough fuel to push back up through resistance.
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The VIX (CBOE Market Volatility Index – a.k.a. “fear gauge”) closed Wednesday at 23.52. It had its sights set on support at 20 before Wednesday’s market weakness pushed it up. But it remains relatively low, especially compared with the higher-volatility environment we have seen so much this year.
The TED spread (indicator of credit risk in the general economy, measuring the difference between the 3-month T-bill and 3-month LIBOR interest rates) has been turned back at the 60 resistance level after rising steadily since the first of August. It closed at 57.92 on Wednesday. This is far above the low teens from earlier this year, and indicates elevated investor worry about bank liquidity and a preference for the safety of Treasuries bonds over corporate bonds.
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, quantitative 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. Bull and Bear are backward-looking indicators of recent sentiment trend.
As a group, these three scores can be quite helpful for positioning a portfolio for a given set of anticipated market conditions.
Observations:
1. Technology (IYW) has completed its rise back to the top of the heap, coming in with a robust Outlook score of 84. This is a 19-point increase from last week. After being held back by Oracle’s (ORCL) weak report last week, the group’s projected P/E looks relatively good, and analysts came out in support. Healthcare (IYH) stays strong with a 76 to hold second place by a comfortable margin over Industrial (IYJ), which has risen to third place.
2. Former leader Basic Materials (IYM) continues to fall in the rankings. It is held back by net downward revisions by the Wall Street community; although it still sports a low projected P/E. Apparently investors still think the analysts are too optimistic, even with the downward revisions.
3. As usual, Telecom (IYZ) is at the bottom. Stocks within IYZ are saddled with the highest projected P/Es. Utilities (IDU), the top performer for the year, has risen out of the bottom two. Consumer Services (IYC) is back in the bottom two. Stocks within this ETF have lost some support among analysts, and they are still dealing with tight margins and low return on sales.
4. Seeing IYW, IYE, IYF, and IYJ in the top half is a relatively bullish sign. It would be better to see IYM and IYC scoring above IYK. It’s also bullish to see the top Outlook score above 80. As a whole, the Outlook rankings for the 10 U.S. sector iShares reflect cautious optimism.
5. Looking at the Bull scores, IYE has been the leader on strong market days, scoring 60, followed by IYM and IYF. IDU remains the weakest with a 42. It is notable that IYW is not a leader on strong market days.
6. As for the Bear scores, IDU is the clear investor favorite “safe haven” on weak market days with a score of 65. IYH comes in second at 62. IWM displays the lowest Bear score of 42, which means that stocks with this ETF sell off the most on weak market days. IYF is close behind.
7. Overall, IYW now displays the best combination of Outlook/Bull/Bear scores. Adding up the three scores gives a total score of 186, although IYH is close behind at 183. IYC is the worst at 128. IYE has the best combination of Bull/Bear with a total score of 108, while IYM has the worst combination (101).
Top ranked stocks in Healthcare and Technology include United Therapeutics (UTHR), Neurocrine Biosciences (NBIX), Apple Inc. (AAPL), and Mistras Group (MG).
These scores represent the view that the Healthcare and Technology sectors may be relatively undervalued overall, while Consumer Services and Telecom 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 sector.
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.