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Sector Detector: Market Latches onto Signs of Stability

Posted on the 08 September 2011 by Phil's Stock World @philstockworld

Sector Detector: Market latches onto signs of stability

Investor distress and uncertainty remain elevated from ongoing natural disasters, mixed economic reports, zero jobs growth, unclear future Fed stimulus, Obama’s jobs plan, and very real European solvency concerns. However, a German court rejected a lawsuit to prevent Germany from participating in European Union bailouts, and the Wednesday rally was on in Europe and spilling over into the U.S. markets, as the S&P 500 closed up nearly 3%.

With Wednesday’s strong rally, gold took a breather and settled down -2.9%. But oil was strong, finishing up +3.9% and carrying the Energy sector along with it. Top-ranked oil stocks in Sabrient’s algorithms were among the leaders, including HollyFrontier (HFC) +8%, Stone Energy (SGY) +7%, and Tesoro (TSO) +5%. The Financial sector was the big leader of Wednesday’s rally, gaining +4.8%, led by Bank of America (BAC) +7%.

Thursday will be a big day, however, with jobless claims in the morning, the European Central Bank (ECB) rate announcement and press conference with Jean-Claude Trichet, Fed Chairman Bernanke’s speech on the economy in the afternoon, and then President Obama’s jobs creation plan in the evening. The market will be on the move.  Obama wants to jumpstart employment by injecting more than $300 billion into the economy next year, mainly through tax credits and infrastructure spending and providing help for the long-term unemployed.

Presidential candidate Mitt Romney released his jobs plan in advance, which includes reducing the corporate tax rate from 35% to 25%, cutting government spending by 5%, waiving “Obamacare” healthcare reform, and boosting domestic energy production. Romney called Obama’s plan an antiquated “payphone strategy…in a smartphone world…”

Keynesian economist and NYU professor Nouriel Roubini thinks that the global economy is in a worse situation than in 2008. “This time around we have fiscal austerity and banks that are being cautious,” he says. The notorious perma-bear believes that a U.S. QE3 wouldn’t have the necessary effect without European stimulus, as well. He thinks that the bond market is already indicating an imminent recession, and he gives a “double dip” a 60% chance by 2012, and he believes China and Brazil are at risk of a “hard landing,” as well.

To be sure, European markets have been quite weak. Have you seen Greek bond yields recently? The 10-year yield was over 20%, the 2-year over 50%, and the 1-year paper over 80%. No one wants to touch them. 

On the other hand, Chris Rupkey, chief financial economist at Bank of Tokyo-Mitsubishi, says that, “Banks are really much more liquid then they were back in 2008,” particularly given the Fed’s lending facilities that were put in place then, and he believes the U.S. will avert another recession. Also, Wharton professor Jeremy Siegel thinks that stocks are 25-30% below his fair market value, and of course we know that Warren Buffett has been buying up value stocks.

Looking at the SPY chart, it got a bounce off the double bottom around 112, and the oversold rally commenced. The channel between 112 and resistance at 121 got an upside resolution last Wednesday, which was bullish, nearly touching the upper Bollinger Band. But then September came and brought along extreme weakness. RSI and MACD were rolling over, as I suggested they might, but are now looking neutral and searching for direction. Volume has held up fairly well considering the end of summer but is still relatively light. Let’s see how the markets react to Thursday’s events. A breakout could lead to tests of resistance at 121, the upper Bollinger Band near 123, and then the 50-day simple moving average at 125. Downside support remains at 112.

Sector Detector: Market latches onto signs of stability

The VIX (CBOE Market Volatility Index – a.k.a. “fear index”) has settled comfortably into the mid-30s and closed Wednesday at 33.38. This is quite a bit higher than the teens it fluctuated in just months ago and might be the “new normal” for the foreseeable future.

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 stabilized now after a steep climb. It closed today at 32.16, which is high and indicates rising 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: Market latches onto signs of stability

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

1.   Healthcare (IYH) hold on to the top spot on the list with an Outlook score of 77. Recall that last week it jumped from sixth place to the top as its Outlook score jumped from 47 to 80 – an incredible 33 points. Healthcare has managed to maintain analyst support while other sectors are getting some reductions in earnings projections. It is a growth sector within an aging population, no matter what the overall economy does.

2.   Financials has jumped all the way from fourth to second place with an Outlook score of 71, followed by Basic Materials (IYM) at 63. On a relative basis, stocks within the Financial sector have had better analyst support recently. It also has a reasonably good aggregate return on sales and the lowest (best) projected P/E.

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). Stocks within Telecom (IYZ) have fared the worst among analysts, and Utilities (IDU) has the lowest projected long-term growth rate. But Utilities as a sector held up the best during the August pullback.

4.   Overall, the Outlook rankings still reflect a conservative slant, as Industrial and Consumer Services continue to slide lower while Healthcare holds at the top.

5.   Looking at the Bull scores, Materials (IYM) is the clear leader on strong market days, scoring 58, followed by Energy. Utilities is the weakest with a 45, followed by Consumer Goods and Healthcare.

6.    As for the Bear scores, Utilities is the clear investor favorite “safe haven” on weak market days with a score of 66. Consumer Goods is a distant second at 60, with Healthcare rising nearby to a 59. Financial has the lowest Bear score of 45, indicating quick abandonment during market weakness – and indeed Financial has tended to lead to the downside 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 182. Utilities (IDU) has the best combination of Bull/Bear with a total score of 111. Both of these are defensive signs.

Top ranked stocks in Healthcare and Financial include Jazz Pharmaceuticals (JAZZ), Humana (HUM), Wells Fargo (WFC), and CNO Financial (CNO).

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 Financial 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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