Sector Detector: Additional Scores Provide New Insights

Includes: IYC, IYH, IYJ, IYK, IYW, IYZ
by: Scott Martindale

After closing November looking quite weak, bulls overpowered the shorts and gave the market an incredibly strong start to December, nullifying all of my previous talk about how the last 4 months of market action were shaping up exactly like the first 4 months of the year (which culminated in the May flash-crash and extended weakness). Instead, powered by the Fed’s QE2 printing press (and hints of a QE3, if needed), the SPY bounced convincingly from strong support at 118 and has not looked back, even powering through November resistance at 123 with only a brief pause to reload.

MACD was starting to cross over bullishly last week, and indeed the ensuing week confirmed the bullishness. All moving averages are pointing upward. Now, the SPY finds itself up against its upper Bollinger Band, its RSI(14) is hitting overbought territory, and it is well extended above its 20-day moving average. As the chart shows, it likes to periodically come back to test support at the 20DMA, so with the MACD getting a bit overbought and rolling over, and with the Bollinger Bands flaring out wider than their norm and due for a reversion, the market will need a pullback to consolidate these gains.

In retrospect, despite an ominous looking chart at the end of November, any expectation of market weakness was “fighting the Fed,” and you know what they say about that (i.e., never do it!). It is possible that this market will keep its bullish trajectory right through year-end, but at least a brief pullback to reload this week is also quite possible. And I still would not be surprised if the market decides to fool a lot of people and have the SPY retest its 20-day moving average (around 121), followed perhaps by 120, 118, and even 115 by late-January. Nevertheless, there are a lot of bulls out there supporting this market with a strong bid every time it shows some weakness.

There was no surprise from the FOMC today, as they gave pretty much the same statement as last time. After the announcement, stocks and treasuries sold off, and the dollar rallied. The market volatility index (VIX) closed today at 17.61, 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) remains very low in its normal range, clocking in at 17.00. Both indicators are relatively low and still reflect complacency.

Latest rankings: This week, I am introducing two additional scores to the SectorCast-ETF table of U.S. sector iShares. In addition to the Outlook Score, which employs a forward-looking fundamentals-based algorithm to create a composite profile of the constituent stocks in each ETF, I am also showing the Bull Score and Bear Score. Many of our clients find these scores quite handy, particularly when reviewed in conjunction with the Outlook Score.

Bull and Bear 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.

You will notice that the range of scores if fairly tight, ranging from 40 to 62. This is because these 10 sector ETFs are diversified baskets of stocks having a wide variety of price performance among their underlying stocks. Nevertheless, these three scores can be quite helpful for positioning a portfolio for a given set of anticipated market conditions.

After a significant reshuffling in Sabrient’s fundamentals-based quantitative SectorCast ETF rankings last week, they are more stable this week. Healthcare (NYSEARCA:IYH) takes back the lead with an Outlook Score of 85, while Technology (NYSEARCA:IYW) has cooled from its rapid rise (all the way up to 88 last week), scoring an 81 this week. Overall, the rankings still indicate a more defensive bias on the market (or perhaps better characterized as “confused”). Consumer Goods (NYSEARCA:IYK) has an Outlook score of 57 to take third place, but IYH and IYW still maintain a huge lead.

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 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.

Consumer Services (NYSEARCA:IYC) is holding onto its resurgent strength this week. It enjoys continued support from the analysts, holding the highest score for analysts increasing earnings estimates while Energy (NYSEARCA:IYE) is seeing a net increase in earnings downgrades.

Top ranked stocks in Healthcare and Technology sectors include Forest Labs (NYSE:FRX), HealthSpring (NYSE:HS), Jabil Circuit (NYSE:JBL), and Fairchild Semiconductor (FCS).

Telecommunications (NYSEARCA:IYZ) remains at the bottom with a score of 16. IYZ has by far the highest projected P/E and the worst return on equity. Industrial (NYSEARCA:IYJ) returns to the bottom two with a score of 31, which is only slightly worse than Energy (IYE) at 33.

Low ranked stocks in Telecom and Industrial sectors include UTStarcom (NASDAQ:UTSI), Sycamore Networks (OTCPK:SCMR), UQM Technologies (NYSEMKT:UQM), and General Maritime (NYSE:GMR).

These scores represent the view that the Healthcare and Technology sectors may be relatively undervalued overall, while Telecom and Industrial sectors may be relatively overvalued, based on our 1-3 month forward look.

From the standpoint of the Bull and Bear scores, Financial (NYSEARCA:IYF) and Basic Materials (NYSEARCA:IYM) have tended to perform the best in recent periods of overall market strength, while (not surprisingly) Utilities (NYSEARCA:IDU) and Consumer Goods (IYK) have held up the best on weak market days.

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