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Sector Detector: Global Teamwork Injects a Dose of Optimism

Posted on the 15 September 2011 by Phil's Stock World @philstockworld

Sector Detector: Global teamwork injects a dose of optimism

Investors dumped equities late last week ahead of the weekend – largely due to the tenuous situation with Greece’s debt and the associated fall in the euro (and a commensurate rise in the dollar). But I also think there was a flight-to-safety ahead of the 9/11 anniversary, especially among Wall Street traders given the terror threats and heavy security in NYC.

This week, however, has brought a glimmer of optimism. Equities are up nicely through Wednesday, with the S&P 500 advancing about 3% since last Friday’s close, led by Industrials, Technology, and Consumer Services sectors, while gold, Treasuries, and the dollar are all slightly down.

Nevertheless, the S&P 500 is still down about 5% year-to-date through Wednesday. But the more optimistic market commentators suggest that U.S. stocks look cheap at 12x earnings projections and with an S&P 500 dividend yield of 2.1%. With cash and bonds yielding almost nothing, stocks look attractive by comparison.

As I mentioned last week, Chris Rupkey, chief financial economist at Bank of Tokyo-Mitsubishi, believes the U.S. will avert another recession. And Wharton professor Jeremy Siegel thinks that stocks are 25-30% below his fair market value, while Warren Buffett has been buying up value stocks, including Financials. Corporations still boast strong balance sheets and can generate good profits even with lackluster demand.

The biggest risk is what is happening in Europe, but a sort of “global teamwork” is in the works to prop up the weaklings. After reports on Monday that China was considering investing in Italy, reports surfaced on Tuesday that Brazil, Russia, India, China, and South Africa (BRICS) are looking into bond purchases to help strengthen the situation. Of course, these exporting nations have a huge vested interest in keeping the economies of Europe and the U.S. healthy enough to keep buying products and commodities from them.

The purchase of European sovereign debt likely would be limited to the bonds of the more stable nations like Germany and Great Britain, and they also might consider providing aid through the International Monetary Fund. Apparently, September 22 is the date when the big “planning meeting” will take place in Washington D.C. between finance ministers and central bank governors of the BRICS nations.

With the Greek 1-year yielding over 100%, things could hardly be more urgent. Nevertheless, both French President Nicolas Sarkozy and German Chancellor Angela Merkel have said that they are convinced Greece will remain in the euro zone.

Looking at the SPY chart, the channel between support at 112 and resistance at 121 got an upside resolution at the end of August, but then September turned it into a false breakout. After rallying nicely back to the top of the channel intraday last Thursday, weakness set in, but now price is again testing the top of the channel. RSI and MACD continue to search for direction. Bollinger Bands have pretty much done their “mean reversion” after becoming quite wide, and they are also searching for new direction. Resistance is at the 50-day moving average (converging with upper BB) and then at 126.

Sector Detector: Global teamwork injects a dose of optimism

The VIX (CBOE Market Volatility Index – a.k.a. “fear index”) remains comfortably in the mid-30s and closed Wednesday at 34.60 – after reaching above 43 intraday on Monday. This is quite a bit higher than the teens it fluctuated in just months ago and reflects investor uncertainty.

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) is once again creeping higher. It traded above 35 before closing today at 34.91. Although is not nearly so high as it was during the financial crisis, it nevertheless 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.

Sector Detector: Global teamwork injects a dose of optimism

Here are some observations about Sabrient’s latest SectorCast scores.

1.   Healthcare (IYH) remain on top with an improving Outlook score of 83. Healthcare is a growth sector within an aging population, no matter what the overall economy does. It has managed to maintain analyst support (on a relative basis) while other sectors are getting net reductions in earnings projections across the board. In fact, all sectors were negative on net revisors this week, but IYH was about flat (equal number of downgrades as upgrades).

2.   Basic Materials (IYM) returns to the second spot with a 72. It has a reasonably good aggregate return on equity and one of the lowest (best) projected P/Es.

3.   Utilities (IDU), Consumer Services (IYC), and Telecom (IYZ) remain at the bottom. IYC is still held back by the worst return on sales (poor margins). Telecom has the highest (worst) projected P/E.

4.   Overall, the Outlook rankings still reflect a conservative slant, as Industrial and Consumer Services remain low while Healthcare holds at the top.

5.   Looking at the Bull scores, Financial (IYF) has been the clear leader on strong market days, scoring 59, followed by Industrial. Utilities and Consumer Goods are the weakest with a 45.

6.    As for the Bear scores, Utilities is the clear investor favorite “safe haven” on weak market days with a score of 67. Consumer Goods is a distant second at 59. Financial has the lowest Bear score of 43, as it leads the market up on strong days and down on weak days.

Overall, Healthcare (IYH) displays the best combination of Outlook/Bull/Bear scores. Adding up the three scores gives it a total score of 187. Utilities (IDU) has the best combination of Bull/Bear with a total score of 112. Both of these are defensive signs.

Top ranked stocks in Healthcare and Materials include Jazz Pharmaceuticals (JAZZ), Humana (HUM), Olympic Steel (ZEUS), and Rockwood Holdings (ROC).

Low ranked stocks in Consumer Services and Telecom include Corinthian Colleges (COCO), Sears Holdings (SHLD), CenturyLink (CTL), and American Tower (AMT).

These scores represent the view that the Healthcare and Materials 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 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.

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