Sector Detector: InfoTech Continues to Sink in Rankings

Scott Martindale

As the stock market continues to trade near its highs, Sabrient’s SectorCast-ETF model remains defensive, given its GARP (growth at reasonable price) focus. The top and bottom ranked sectors remain the same this week, but there was noticeable movement in the middle. In particular, Information Technology is dropping while Telecommunications rises.

Latest rankings: This week, Sector Detector tells us that Healthcare (XLV) continues to lead with an eye-popping score of 93 (on a scale of 100), powered primarily by its low aggregate projected price to earnings ratio for the constituent stocks. It also benefits from

analyst upward earnings revisions and a solid trailing 12-month return on equity. Consumer Staples (XLP) solidified its place in the second spot with a strong score of 82. Top-ranked stocks within these sectors include Humana (NYSE: HUM), CareFusion (NYSE: CFN), Colgate-Palmolive (NYSE: CL), and Dean Foods (NYSE: DF).

Materials (XLB) continues to pull up the rear as the fundamentally weakest sector, scoring a dismal 26. It has the highest aggregate projected P/E and a negative trailing 12-month return ratios. Industrials (XLI) is again in ninth at 33. Low-ranked stocks within these sectors include Alcoa (NYSE: AA), Vulcan Materials (NYSE: VMC), Eaton (NYSE: ETN), and PACCAR (Nasdaq: PCAR).

In the middle of the rankings, Telecom (IYZ) has moved up three spots in the wake of several analyst upward revisions to earnings estimates—rising from a score of 42 last week to today’s 55. On the other hand, InfoTech (IYW) and Energy (XLE) both dropped two spots primarily due to an aggregate net reduction in analyst earnings estimates among their constituent stocks. The SectorCast score for IYW fell from 67 to 54, and XLE fell from 55 to 44.

These scores represent the view that Healthcare and Consumer Staples stocks may be undervalued, while Materials and Industrials stocks may be overvalued.

Performance: The table below shows the performance of each week’s portfolio as of the market close on Tuesday, 12/01/09. The top-ranked XLV has nicely outperformed the SPY, although the IYW has slipped a bit lately in relative performance.

You can see that the long/short ETF portfolio from the beginning of the month is still lagging the SPY badly, which can happen during strong momentum rallies in which the more speculative names lead the market. But more recent portfolios are holding their own against a straight long position on the market, illustrating that a sound absolute return approach can be effective in any market climate.

Disclosure: Author has no positions in stocks or ETFs mentioned.

About SectorCast: The rankings are based on Sabrient’s SectorCast model, which builds a virtual profile of each of the 10 ETFs in the table below based on bottom-up scoring of their constituent stocks. The model employs a fundamentals-based multi-factor approach including forward valuation, earnings growth prospects, analyst revisions, and various return ratios.

SectorCast has tested to be highly predictive for identifying the best (most undervalued) and worst (most overvalued) sectors, with a 1-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 8 Select Sector SPDRs, but because the SPDRs combine InfoTech and Telecom into one ETF, I use the two iShares for those sectors rather than the SPDR Select Technology ETF.

About Trading Strategies: Sector Detector has shown how you can use this information in three ways to identify ETFs that have the potential to enhance your upside, downside, or market-neutral trading ideas. First, if you are bullish on the broad market, you can go long the SPDR Trust exchange-traded fund (SPY), which tracks the S&P 500 Index, and enhance it with long positions in SectorCast’s 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 really don't want to bet on which way the market is going, you could try a market-neutral, long/short trade—that is, go long the top-ranked ETFs and short 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.

About Performance Tracking: I track each week’s set of ETFs as a mini-portfolio over the course of four weeks. Because SectorCast does not include any technical triggers, this will give the fundamentals-based model a chance to achieve its predicted move.

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