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Sector Detector: Basic Materials Surges in Rankings

Wed, Feb 2, 3:26 AM ET, by Scott Martindale, Sabrient.com

The past few days have given us a wild ride in the markets, thanks primarily to unrest in the Middle East. After this extended run since December 1, I have been waiting for the market to decide between either pulling back to consolidate gains and find a strong support point from which to launch on a renewed bullish run … losing critical support and turning bearish.

Looking at the SPY chart, Friday gave us a big red candle and a scary break of both the uptrend line and 20-day moving average that I was waiting for, after a long period in which it barely tested them. Then, for the first time in two months, RSI reached back down to the neutral line, where I was looking for it to either bounce or continue to cycle down to oversold territory, while the MACD was only just starting its decent from overbought. As it has turned out, RSI has bounced strongly. Price stabilized on Monday and then gapped higher today, pushing the Dow and S&P500 to heights they haven't reached in over two years. RSI and MACD have been turned back up sharply, as well, and we might be seeing something of a bullish “cup & handle” pattern.

I was hoping for more weakness this week to shake out some of the weaker momentum holders and give the market a firmer foundation from which to continue its rally, but with the dollar cratering and industrial production up, investors took it as a green light to scoop up stocks now rather than later (and risk missing out). I have been suggesting that a pullback would likely be shallow and short lived, but this one was awfully quick. I'm not so sure that's all we're going to get.

The market volatility index (VIX) closed today at 17.63 after spiking over 20 on Friday, 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) is at 16.34, which is up only slightly since last week. Both indicators remain relatively low and still reflect complacency (and investor optimism).ETF rankings" src="http://sabrient.com/blog/images/SabrientSectorCastETF-012811.jpg" alt="" width="390" height="353" />

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 Healthcare and Technology, but Basic Materials has made a notable surge in the rankings. Technology (IYW) returns to the top spot this week with an Outlook Score of 89. Healthcare (IYH) remains strong with an 83. These two have consistently scored at the top as their performance hasn't outrun reasonable valuation and analyst expectations.

Basic Materials (IYM) made a huge surge this week – leaping 28 points from with a score of 53 to an impressive 81 – as analysts boosted earnings estimates for stocks in the sector.

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

Telecommunications (IYZ) of course shows up again in the cellar with a 16, as the U.S. Telecom companies just don't show much in the way of compelling growth or projected valuations. Consumer Services (IYC) weakened significantly, and joins IYZ in the bottom two this week with a score of 24.

Looking at the Bull and Bear scores, Basic Materials (IYM) and Technology (IYW) have tended to perform the best in recent periods of overall market strength, while not surprisingly Healthcare (IYH) and Utilities (IDU) have held up the best on weak market days. Overall, I would say that Technology (IYW) boasts the best combination of the three scores.

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. 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 P/E, projected year-over-year change in earnings, and analysts increasing earnings estimates.

Top ranked stocks in Healthcare and Technology include Sanmina (SANM), Fairchild Semiconductor (FCS), HealthSpring (HS), and Forest Labs (FRX).

IYZ has by far the highest projected P/E and the worst return on equity. IYC is notably weak in return on sales as retail margins continue to be squeezed despite improving consumer spending.

Low ranked stocks in Telecom and Consumer Services include American Tower (AMT), Terremark Worldwide (TMRK), Amazon.com (AMZN), and Six Flags Entertainment (SIX).

These scores represent the view that the Healthcare and Technology 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.


SDI Glossary: "CD" Definition
SDI Glossary: "price" Definition
SDI Glossary: "ETFs" Definition
SDI Glossary: "iShares" Definition
SDI Glossary: "MACD" Definition
SDI Glossary: "Sector" Definition
SDI Glossary: "VIX" Definition
This Article's Word Cloud:   Bear   Bull   ETFs   Healthcare   Outlook   Sabrient   Score   SectorCast   Technology   based   best   constituent   days   during   each   earnings   either   equity   forward   from   have   high   long   market   month   particularly   perform   periods   projected   ranked   rankings   relatively   return   score   scores   sector   sectors   short   stocks   strong   tended   that   this   weak   week   well   which   while   with   within

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