Sector Detector: Technology Leads Rankings, while Energy Finds All-Weather Support

The market reeked of late-day manipulation today as a last-minute push managed to get the Dow back into positive territory, but the S&P500 and Nasdaq couldn’t quite make it. The bulls have staked out their claim and won’t allow anyone to spoil their party...and they have powerful friends. Although an occasional pullback to test support at the uptrend line and 20-day and 50-day moving averages is typically a sign of a healthy market, the bulls are taking their freshly minted bills from their buddies at the Fed straight to the stock exchanges for fun and profit.

During the last week of January, the market tested resistance at major psychological levels of Dow 12,000 and S&P500 1300, and then the unrest in Egypt led it to test support from the uptrend line. Undaunted, the bulls took control once again last week to push strongly through those resistance levels…and they haven’t looked back.

Bellwethers like Disney (DIS) and Coca-Cola (KO) came out this morning with good earnings reports to cheer the market. However, Cisco Systems (CSCO) made an afterhours attempt to interrupt the gaiety with cautious statements, but there was little collateral damage. We’ll see how the market reacts on Thursday.

Looking at the SPY chart, it is once again consolidating gains at the upper Bollinger Band, trying to work off overbought indicators like the RSI and MACD without giving up much in price. This has been an ongoing theme and an indication that the bulls and their supporters are firmly in charge.

Corporate cash levels remain high, and M&A activity continues. This week, Danaher (DHR) announced it would acquire Beckman Coulter (BEC), driller Ensco PLC (ESV) is buying Pride International (PDE), creating the world's second-largest offshore-drilling contractor after Transocean Ltd. (RIG), and the London Stock Exchange will acquire TMX Group (owner of the Toronto Stock Exchange).

Fear as measured by the market volatility index (VIX) is back to low levels, reflecting investor confidence and complacency. Although it had spiked to above 20 during the initial crisis in Egypt, it has since returned to its long-term support around the 16 level. It closed today at 15.87, after performing an impressive swan dive from 16.40 in the last few minutes of the trading day. The TED spread (i.e., indicator of credit risk measuring the difference between the 3-month T-bill and 3-month LIBOR interest rates) is up to 18.52, which is up notably, but still low in its normal range. It had been in the 13-14 range recently. This increase is less bullish.

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 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.

As a group, these three scores can be quite helpful for positioning a portfolio for a given set of anticipated market conditions.

Sabrient’s SectorCast ETF model continues to favor Technology (IYW) and Healthcare (IYH). IYW has crept back up into above 90, scoring 91 this week, while IYH stays at 83. Basic Materials (IYM), which surged 28 points last week, pulled back 7 points this week to 74 but still maintains a solid hold on third place. IYW and IYH have consistently scored at the top as their performance hasn’t outrun reasonable valuation and analyst expectations.

Notable movers this week include Financial (IYF) dropping 9 points from 58 to 49 and Energy rising 10 points from 37 to 47. Industrials (IYJ) moved up one spot to fifth and now scores a 50.

It is still encouraging for bulls to see that five of the 10 sector ETFs are scoring above the 50 mid-point score, reflecting optimism among analysts.

Telecommunications (IYZ) remains at the bottom with a score of 11, as the U.S. Telecom companies just don’t show much in the way of compelling growth or projected valuations. Consumer Services (IYC) holds its spot in the bottom two, once again scoring 24.

Looking at the Bull and Bear scores, stocks within IYF, IYM, IYE, and IYW have all tended to perform the best in recent periods of overall market strength, as reflected by their high Bull scores. These are the more “offensive” sectors. Traditionally “defensive” sectors represented by IYH, IDU, and IYK not surprisingly have held up well on weak market days, as reflected by their Bear scores, but it is notable that IYE and IYW are also posting strong Bear scores. This is indicative of a confident bull market. 

Overall, Technology (IYW) still boasts the best combination of the three scores, but Energy (IYE) has been displaying the best combination of Bull and Bear scores, which tells me that investors have been favoring Energy stocks no matter whether the market is strong or weak.

IYW remains strong across most all factors in the quantitative model, scoring highly (on a composite basis across its constituent stocks) in return on equity, return on sales, projected year-over-year change in earnings, and analysts increasing earnings estimates. IYH continues strong in return on equity and return on sales, and it has by far the lowest (best) projected P/E, although its long-term growth rate is a bit suspect. IYE and IYJ strengthened quite a bit this week in analysts increasing earnings estimates, which accounts for their strengthening in the rankings.

Top ranked stocks in Technology and Healthcare include Integrated Silicon Solution (ISSI), Jabil Circuit (JBL), Triple-S Management (GTS), and Forest Labs (FRX).

IYZ has by far the highest projected P/E and the worst return on equity. It also has absorbed a number of analyst earnings downgrades. IYC is notably weak in return on sales as retail margins continue to be squeezed despite improving consumer spending. It also has a relatively high projected P/E.

Low ranked stocks in Telecom and Consumer Services include Equinix (EQIX), Leap Wireless International (LEAP), Zale Corp. (ZLC), and drugstore.com (DSCM).

These scores represent the view that the Technology and Healthcare sectors may be relatively undervalued overall, while Telecom and Consumer Services 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.

Sector Detector
smartindale / Tag: ETF, FRX, GTS, IDU, iShares, ISSI, IYC, IYE, IYF, IYH, IYJ, IYK, IYM, iyw, IYZ, JBL, linkedin, long/short, sector, sector-rotation /