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Sector Detector: Technology and Consumer Services Surge in Rankings
In last week’s article, I suggested that the market needed to confirm that it was indeed in breakout mode above the SPY 120 level, and the past week gave unequivocal confirmation. After closing November looking quite week, a strong underlying bid overpowered the shorts and gave the market an incredibly strong start to December. Still this has been a news-driven and highly-manipulated market, backed by your classic “Don’t Fight the Fed” mantra, so such technical interpretations have been far less predictive than usual.
I’ve been talking for several weeks about how the SPY chart had been shaping up for the past 4 months almost identically to the first 4 months of the year and threatening another big selloff like we saw in May. As shown on the attached chart, the break of the 40-day moving average on Tuesday seemed to correspond to the similar break on May 4, and suggested that a similar selloff might be in the offing. But rather than another “flash crash” like we had on May 6, the strong start to December has pretty much nullified all of that talk.
As it turned out, SPY 118 provided strong support once again – and in fact turned out to be a launching pad. Nevertheless, a test of support at the 20-day moving average just above SPY 120 (and S&P500 1200), followed by retests of prior resistance-turned-support at SPY 115 is quite possible – and needed, I think, to confirm the bulls' resolve. SPY momentarily stopped at November resistance at 123 on Monday, but then busted out through it today before struggling into the close to hold it as support (which it failed to do, by the way, closing at 122.83).
Today’s close gives an indication of a sell-the-news event in the wake of the deal extending the Bush-era tax cuts to all while also extended unemployment benefits. But despite closing weakly and back under resistance at SPY 123, technical levels of resistance tend not to matter much these days, and the market’s underlying bid sure seems to remain intact as the Fed's money machine stays in high gear, with fresh Monopoly money (a.k.a., fiat currency) sloshing about and looking for a home…and usually finding it in the stock market.
After spiking last week to almost 24 as November closed weakly, the market volatility index (VIX) broke strong support today at 18 to drop as low as 17.13, before spiking late to close right back near support at 17.99. Also, 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 16.73. Both indicators still reflect complacency.
Latest rankings: Lots of reshuffling in Sabrient’s fundamentals-based quantitative SectorCast ETF rankings this week. Healthcare (IYH) still scores about the same, coming in with an 81, but Technology (IYW) is continuing its surge, jumping into the top spot with an 88 after last week’s 82 and a 74 the prior week. Overall, the rankings still indicate a more defensive bias on the market (or perhaps better characterized as “confused”). Consumer Goods, Utilities, and Energy ETFs dropped somewhat, while Technology, Basic Materials, and Consumer Services ETFs rose. On balance, that sounds like an overall improvement in optimism, but I’m not so sure yet. Let’s see how the coming weeks play out with the rankings.
The biggest movers week-over-week were Energy (IYE), which has now fallen to a score of 27 and in the bottom two, and Consumer Services, which jumped an incredible 20 points from 21 last week all the way to 41 this week, thus leapfrogging over Energy, Industrial, and Utilities.
Healthcare (IYH) stays flat with an 87 this week, while Technology (IYW) jumps from 74 to 82, and Financial (IYF) moves up from 64 to 69. IYH continues strong in return on equity, return on sales, projected P/E (low valuation), and analysts increasing earnings estimates that really drove its dominant ranking. IYW remains pretty strong across the board, too, scoring highly (on a composite basis across its constituent stocks) in return on equity, return on sales, projected P/E, projected year-over-year change in earnings, and analysts increasing earnings estimates. In fact, while analyst upgrades tapered off among the other sectors, stocks within IYW held strong among the analysts.
Top ranked stocks in Healthcare and Technology sectors include Kinetic Concepts (KCI), HealthSpring (HS), Google (GOOG), and Fairchild Semiconductor (FCS).
Telecommunications (IYZ) remains at the bottom with a score of 20, but that is much improved over last week’s 13 and the recent score of zero. Energy (IYE) is the new partner in the bottom two with a score of 27. Analysts increased earnings estimates for stocks in the sector made the biggest difference, as Consumer Services (IYC) has by far the most recent support while Energy (IYE) is seeing a net increase in earnings downgrades. IYZ has by far the highest projected P/E and the worst return on equity, although the analysts haven’t been quite so hard on the stocks in this sector lately.
Low ranked stocks in Telecom and Energy sectors include UTStarcom (UTSI), Crown Castle International (CCI), ATP Oil & Gas (ATPG), and EOG Resources (EOG).
These scores represent the view that the Technology and Healthcare sectors may be relatively undervalued overall, while Telecom and Energy 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 model employs a fundamentals-based multi-factor approach considering forward valuation, earnings growth prospects, Wall Street analysts’ consensus revisions, accounting practices, and various return ratios.
SectorCast has tested to be highly predictive for identifying the best (most undervalued) and worst (most overvalued) sectors, with a one-month forward look. 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.