Sector Detector: Record Levels of Corporate Cash Looking for Buys
Tue, Aug 24, 9:16 PM ET, by Scott Martindale, Sabrient.com
 As I pointed out back in June, cash on hand among S&P 500 companies has been at record levels, and up 25% over the same time last year. One would presume that such cash levels would eventually be used for share buybacks, M&A, or dividend increases – all of which would impact the market favorably.
Well, there are signs that the purse strings are loosening up. Last week, BHP Billiton (BHP) made a bid for Potash (POT). Then, Intel (INTC) moved on McAfee (MFE), and this week Hewlett-Packard (HPQ) is bidding against Dell (DELL) for data storage firm 3PAR (PAR). Now there's speculation about potential deals in the oil & gas sector, given the huge capital requirement for exploration & production in remote areas. When the BHP/POT announcement came out last Tuesday, the market took it as a sign of impending M&A mania and a reason to soar, but the excitement only lasted one more day before the selling set in. Bears got more aggressive today after the release of existing home sales for July. Sales dropped -27% month-over-month to an annualized rate of 3.8 million units – far below expectations of 4.7 million units and the worst since records began in 1999. Housing supply is now 12.5 months. I think the constant talk about a double dip in housing is becoming a self-fulfilling prophesy as lenders and buyers alike listen to the news and become afraid to either lend or buy. Anecdotally, I'm hearing that some institutions are calling in small business loans that are collateralized by real estate, in an effort to reduce their exposure. Now all major indexes are far below their moving averages and looking quite weak. Market volatility represented by the VIX spiked above recent resistance at 28 before settling back below. Gold (GLD) is serving as a safe haven and catching a bid, the U.S. dollar (UUP) is strengthening, and treasuries (e.g., TLT) are going through the roof, while oil (USO) has been selling off worse than stocks. You have probably heard of the “TED spread.” It is the difference between the 3-month T-bill and 3-month LIBOR interest rates, so it is an indicator of perceived credit risk. Its typical range is 10-50 bps, but reached above 400 during the credit crisis in 2008 and near 48 during the June selloff this year (when the VIX was spiking above 35). However, the TED spread today is all the way back down to 16.25, which reflects positive sentiment about the health of the economy. Perhaps there is a foundation of optimism yet. Latest rankings: Sabrient's SectorCast-ETF ranking of the ten U.S. industrial sectors is still reflecting a slightly bearish bias. The model employs a fundamentals-based multi-factor approach including forward valuation, earnings growth prospects, recent analyst consensus sentiment, and various return ratios. Other than the high ranking for Technology, the current quant rankings continue to reflect a cautious stance among analysts, which I have been reporting to be a moderately bearish sign for the markets. And this interpretation has been panning out. This week, Technology (IYW) remains the highest ranked ETF with a score of 85, matching last week's score. IYW is strong across the board, and scores particularly well (on a composite basis across its constituent stocks) in the percentage of analysts increasing earnings estimates, return on equity, return on sales, and projected year-over-year change in earnings. The second place spot again goes to Healthcare (IYH), whose score has stabilized this week at 74 after dropping significantly the prior few weeks. It is strong in return on equity, return on sales, and projected P/E. Energy (IYE) is holding on to third place with a 65. Top ranked stocks in IYW and IYH include RF Micro Devices (RFMD), Lexmark (LXK), Forest Labs (FRX), and Endo Pharmaceuticals (ENDP). At the bottom of the list, Telecom (IYZ), with the highest PPE and poor return on equity, continues to land dead last with a score of 1. Joining it in the bottom two yet again is Consumer Services (IYC), scoring a 21 primarily due to tight margins cutting into return on sales. It also scores poorly on the percentage of analysts increasing earnings estimates. Retailers and their Wall Street analysts remain gloomy about the near term outlook. Once again this week, IYM and IYZ were the only sectors that had net analyst downgrades to earnings estimates. Low ranked stocks in IYZ and IYC include American Tower (AMT), Sprint Nextel (S), MGM Resorts International (MGM), and Live Nation Entertainment (LYV). 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: The rankings are based on Sabrient's SectorCast model, which builds a composite profile of each of the ten ETFs 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 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 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 (2 longs and 2 shorts) 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. You might also watch just the two long positions as a separate long-only sector rotation strategy.
SDI Glossary: "ETFs" Definition
SDI Glossary: "iShares" Definition
SDI Glossary: "Sector" Definition
SDI Glossary: "VIX" Definition
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