Sector Detector: Stocks Make a 7-day Patriotic Rally

Reminder: Sabrient is available to chat with Members, comments are found below each post. Courtesy of Scott Martindale, Senior Managing Director, Sabrient Stocks have had a great run over the past seven trading days, after a double bottom chart formation provided a launching pad, and with a little bit of good economic news sprinkled in at opportune moments along with a patriotic Fourth of July holiday. The ADP Employment Report, initial jobless claims and continuing claims all come out on Thursday, and then the June Employment Situation and non-farm payrolls on Friday. We’ll see if it turns this into something more than just an oversold bounce. The bulls have found strong breadth and leadership in all the right places, as Technology, Industrials, Basic Materials, Energy, Consumer Discretionary, and even Financials have been taking turns leading the way throughout this 7-day run. We still have all the same goblins out there threatening to derail the market rally, but bulls appear to be undeterred by such pesky details. After all, where else is an investor to go these days? QE2 ended without much fanfare, and while there won’t be any more injections of freshly minted bills into the system, the dollars that already have been injected will be allowed to keep circulating for the foreseeable future. The dollar itself seems to have settled into a narrow trading range at current levels, and stock investors seem to be okay with that. But if the dollar strengthens considerably, such as due to renewed debt woes in Europe, that likely won’t bode well for a continued stock rally. Since the beginning of June, the Dow has lost/recaptured/lost/recaptured the 12,000 level, and the Russell 2000 has lost/recaptured/lost/recaptured the 800 level. However, the S&P 500 couldn’t recapture the 1300 level earlier in June, which may have pulled the whole market down with it. But last Wednesday, it broke through with conviction, allowing the overall market to rally. If the employment reports aren’t too depressing, it might take a run at the year’s highs. Looking at the SPY chart, the 200-day moving average provided support for a double bottom and a nice bounce point. History shows that after riding along the lower Bollinger Band, price tends to make its way back up to the top band, which it has done. In fact, Friday took it well above the upper band, and now the market is waiting for the upper band to come back up to it. Last Wednesday, prior resistance at 130 was easily surpassed. Then on Thursday, SPY closed at the convergence of: 1) the upper Bollinger Band, 2) prior support-turned-resistance at 132, 3) the 50- simple moving average, and 4) the 100-day simple moving average. Each by itself could have put up resistance, but combined should have been very tough. But after a cautious start to the day on Friday, good economic news sent the market soaring.   After making bullish crossovers, RSI and MACD appear to be flattening out while volume is shrinking. SPY seems to be catching a breather and might try to form a bull flag–and perhaps test support at 132–before moving higher. The TED spread (i.e., indicator of credit risk in the general economy, measuring the difference between the 3-month T-bill and 3-month LIBOR interest rates) closed at 24.07, which is still within its recent 20-25 trading range. However, it has been testing resistance again in what might be considered a bullish ascending triangle. A breakout would indicate some level of elevated fear. On the other hand, the CBOE market volatility index (VIX) closed at 16.24, which is quite low its range. It fell as low as 15.12 intraday last Friday. This indicator of fear is reflecting investor complacency. 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. Here are some notable observations in Sabrient’s SectorCast scores this week. 1. Technology (IYW) is holding firmly to the top spot with a strong Outlook score of 95. Net earnings upgrades among analysts is still pretty neutral going into earnings season, but Technology remains slightly net positive in this important metric. Last week, IYW was still below its important 200-day moving average, but is now well above all its daily moving averages – and once again showing the leadership the market expects from Tech. 2. Basic Materials (IYM) retains its Outlook score of 75. It carries a strong projected P/E and return on equity. The sector has been a leader in this market rally, as reflected by its leading Bull score of 60.  3. Energy (IYE) got a 13-point pop in its Outlook score to 59. It now sports the best (lowest) projected P/E. It is also strengthening in both its Bull and Bear score, as investors seem to be returning to a stabilizing and/or rising oil price mindset. 4. Utilities (IDU) and Telecom (IYZ) remain near the bottom due to only modest support among analysts and relatively high projected P/E.  5. Although its overall Outlook score is modest, Consumer Services (IYC) continues to get the bulk of the analyst upgrades and now sports the highest projected long-term growth rate (beating out Tech and Industrial), which is a good sign. 6. Financial (IYF) is held back by net downgrades among analysts, and it remains the weakest in this important metric. It also is plagued with low return ratios, but it has an attractive projected P/E. 7. The forward-looking Outlook rankings continue to reflect a cautiously bullish bent, in my opinion, with top scores in the economically-sensitive sectors like Tech, Materials, Energy, and Industrial. It would be more bulllish to see Consumer Services (IYC) and Financial (IYF) scoring higher. 8. Looking at the Bull scores, Basic Materials (IYM) and Energy (IYE) are clearly the strongest on strong market days with a score of 60, followed by Industrial (IYJ). Utilities (IDU) is the weakest. Financial (IYF) improved 5 points this week given its solid performance during last week’s market rally (although its performance was poor today). As I have been saying, Financial needs to provide some footing and behave better on bullish days if the market is going to get real traction. 9. As for the Bear scores, Utilities (IDU) is the clear investor favorite on weak market days with a score of 63. Defensive sector Consumer Goods (IYK) is a distant second. Basic Materials (IYM), which has the best Bull score, has been the clear laggard on weak market days, reflecting quick abandonment among investors.  Overall, Technology (IYW) displays the best combination of Outlook/Bull/Bear scores. Adding up the three scores gives it a total score of 195. Energy (IYE) and Consumer Goods (IYK) now share the best combination of Bull/Bear with a total score of 106. Top ranked stocks in Technology and Basic Materials include Baidu Inc. (BIDU), Apple Inc. (AAPL), Huntsman Corp (HUN), and Kronos Worldwide (KRO).   Low ranked stocks in Utilities and Telecom include Cheniere Energy Partners (CQP), Clean Energy Fuels (CLNE), American Tower (AMT), and DigitalGlobe Inc. (DGI). These scores represent the view that the Technology and Basic Materials sectors may be relatively undervalued overall, while Utilities 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. Tweet This Post This entry was posted on Wednesday, July 6th, 2011 at 5:42 pm and is filed under Immediately available to public. You can leave a response, or trackback from your own site. Do you know someone who would benefit from this information? 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