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Sector Detector: Healthcare and Technology Retain Top Scores as Holidays Arrive
The bulls continue to steamroll bears during December, despite closing November with ominous weakness. Powered by the Fed, the SPY bounced convincingly from strong support at 118 and has not looked back, even powering through November resistance at 123 with only a brief pause to reload. Last week it began consolidating those gains with a minor pullback and working off some of the overbought technical conditions, but this week the bulls said, “that’s enough!” and the pullback was magically reversed before giving back much in price. Now there are only blue skies above. That should teach bears about what happens when you try to “fight the Fed.”
MACD and RSI hardly got a chance to work off their overbought status, and Bollinger Bands are widening again after a brief try at mean reversion. As shown in the 6-month chart, September provided an almost identical reversal to a highly bearish chart pattern at the close of August, and you can see what the market has done since then.
I still think SPY will get at least a touch of its 20-day moving average soon. As the chart shows, it likes to periodically come back to test support at the 20DMA, and it has remained quite extended from it all month. On the other hand, SPY seems determined to touch its upper Bollinger Band again soon, so we might see it rally straight into the New Year. With the Fed’s POMO money acting as an unlimited source of fuel, there’s no telling how long this run can last without a significant correction. Just keep in mind that corrections tend to happen when market participants least expect it.
The market volatility index (VIX) closed today at 15.45, and the TED spread (i.e., indicator of credit risk measuring the difference between the 3-month T-bill and 3-month LIBOR interest rates) remains very low in its normal range, clocking in at 17.60. Both indicators are relatively low and still reflect complacency, but VIX is especially so, approaching its extreme lows from April.
Latest rankings: Last week, I introduced two additional scores to the SectorCast-ETF table of U.S. sector iShares. In addition to the Outlook Score, which employs a forward-looking fundamentals-based algorithm to create a composite profile of the constituent stocks in each ETF, I am also showing the Bull Score and Bear Score.
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. Many of our clients find these scores quite handy, particularly when reviewed in conjunction with the Outlook Score.
You will notice that the range of scores if fairly tight, ranging from 40 to 62. This is because these 10 sector ETFs are diversified baskets of stocks having a wide variety of price performance among their underlying stocks. Nevertheless, these three scores can be quite helpful for positioning a portfolio for a given set of anticipated market conditions.
Due to the impending holidays, I’m going to keep today’s Sector Detector article brief. The table shows that little has changed since last week in the rankings. These scores continue to represent the view that the Healthcare (IYH) and Technology (IYW) sectors may be relatively undervalued overall, while Telecom (IYZ) and Industrial (IYJ) sectors may be relatively overvalued, based on our 1-3 month forward look.
From the standpoint of the Bull and Bear scores, Basic Materials (IYM), Energy (IYE), and Financial (IYF) have tended to perform the best in recent periods of overall market strength, while (not surprisingly) Utilities (IDU) and Consumer Goods (IYK) have held up the best on weak market days. Technology (IYW) seems to boast the best overall combination of the three scores.
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.