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Sector Detector: More of the Same

Posted on the 07 June 2012 by Phil's Stock World @philstockworld

Sector Detector: More of the same

Greece, Spain, Italy. Eurozone. Austerity. For stock investors, it’s just more of the same—the same rollercoaster of hope and despair about any of a number of potential outcomes…without resolution. On Wednesday, stocks had their strongest one-day rally since December. Ostensibly, it was due to word on the street that central banks and the Fed will coordinate a global money-printing operation to deliver us all from the threat of global recession.

Whatever the cause of Wednesday’s rebound, whenever the charts are buried in the depths of oversold territory, anticipation of a sudden reversal is high, and nobody wants to be the last one on the bandwagon if and when the tide turns. A hopeful story like we heard on Wednesday will often lead to a powerful relief rally. But will there be follow-through? Well, the fact that traders didn’t take profits before the close of trading is a promising sign.

Fed Chairman Ben Bernanke is scheduled to testify before a congressional committee on Thursday. And the new Greek elections are set for June 17, which may determine the future of Greece as a member of the monetary union. With their 10-year bond yielding over 30%, something is going have to change. But if they want to print their own money, it will have to be a return to the Drachma.

SPY closed Wednesday at 131.97 to get back to where it was last Wednesday and recapture the 200-day simple moving average that it had briefly lost. The bear flag pattern from last week was indeed confirmed on Friday, but the chart suddenly looks much better after Wednesday’s strength. RSI and Slow Stochastic diverged from price by forming higher lows. MACD looks less impressive, but might be ready to turn up, as well.

Sector Detector: More of the same

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) closed Wednesday at 39 bps, holding the same level that appears to be its new comfort zone. The VIX (CBOE Market Volatility Index—a.k.a. “fear gauge”) closed Wednesday at 22.16, down 10% on the day. Given the persistent worries about global recession, both VIX and TED remain low.

As a reminder, The MacroReport provides an in-depth analysis of the macroeconomic trends in around the world and their impact on the U.S., along with actionable ideas (U.S. stocks and ETFs). Complimentary access is still available on Sabrient’s web site through MacroReport InterActive. The current issue focuses on global oil. The March and April issues talked about scenarios that might play out in Greece and in China.

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: More of the same

Observations:

1. The rankings are holding steady with only minor shuffling. Technology (IYW) remains in the top spot with a 84 this week, followed by Healthcare (IYH) at 74. Industrial (IYJ) remains in third, followed by Financial (IYF), Basic Materials (IYM), and then Consumer Services (IYC). This is a bullish top six, and all of them have an Outlook score of 50 or higher.

2. Utilities (IDU) and Telecom (IYZ) remain in the bottom two. IDU is saddled with the lowest long-term growth rate, and IYZ has the highest (worst) forward P/E. With Consumer Goods (IYK) in the bottom four, we see that defensive sectors bunched at the bottom. Also, stocks within Energy (IYE) continue to be downgraded by the analysts.

3. Looking at the Bull scores, Basic Materials (IYM) has been quite strong on strong market days, scoring 58, followed by Financial (IYF), Industrial (IYJ), and Energy (IYE). Utilities (IDU) is by far the weakest on strong days, scoring 38.

4. Looking at the Bear scores, Utilities (IDU) remains the investor favorite “safe haven” on weak market days, scoring a strong 69, followed by Telecom (IYZ), Consumer Goods (IYK), and Healthcare (IYH). Materials (IYM) has the lowest Bear score of 45. Stocks within IYM have tended to sell off the most when the market is pulling back.

5. Overall, IYW now shows the best all-weather combination of Outlook/Bull/Bear scores. Adding up the three scores gives a total of 186. IYZ is the worst at 115. IDU reflects the best combination of Bull/Bear at 107, mainly due to its huge Bear score. Healthcare (IYH) displays the worst combination with a 101.

These scores represent the view that the Technology and Healthcare sectors may be relatively undervalued overall, while Telecom and Utilities sectors may be relatively overvalued based on our 1-3 month forward look.

Top-ranked stocks within Technology and Healthcare sectors include NetEase (NTES), Red Hat (RHT), Questcor Pharmaceuticals (QCOR), and POZEN Inc. (POZN).

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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