Sector Detector: Market Back In Holding Pattern

by: Scott Martindale

During the month of May, the Dow Industrials managed only five positive days, but June has offered up some recovery so far. Despite the persistently negative news we are inundated with each day—creating real trepidation among investors— there are actually a lot of promising signs here in the U.S., and the technical picture seems to have entered a holding pattern as investors await signs of improving stability elsewhere.

To that end, European leaders launched a $125 billion bailout of Spanish banks. Obviously, bond rates in the latest hot spots like Spain and Italy need to come down, preferably below 6%, to achieve some stability. After all, Italy carries a ton of debt—only Japan and the U.S. carry a bigger load. Also, the ECB endorsed a plan for a banking union and a bank deposit guarantee program to calm investor fears about the safety of their deposits. We will likely witness even more programs rolling out as they seek to calm markets by demonstrating resolve.

If they are successful, given the mass exodus of equity investors from European stocks, we might be seeing a major buying opportunity forming in Europe. But let's take one step at a time. For the moment, the big event is Greece's new election this Sunday. At this point, anything is possible, as both the far right and far left appear to have roughly equal support among the electorate.

SPY closed Wednesday at 132.07. It has entered a holding pattern for the past week, awaiting a catalyst to either break out or break down. The prior bear flag pattern shown was initially confirmed, but the 200-day simple moving average provided immediate support, and now SPY is churning smack dab between its 100-day and 200-day SMAs and between its upper and lower Bollinger Bands. RSI, MACD, and Slow Stochastic are giving few clues, even though last week they diverged from the price breakdown by forming higher lows.

A longer-term chart (over one year) shows that important support sits near 125. A breakdown below the 200-day SMA and the 125 level would not bode well. But bulls seem to be willing to put up a fight.

The TED spread (indicator of credit risk in the general economy, measuring the difference between the 3-month T-bill and 3-month LIBOR interest rates) closed Wednesday at 38 bps, holding the same level since mid-February. The VIX (CBOE Market Volatility Index—a.k.a. "fear gauge") closed Wednesday at 24.27, up 10% on the day. It has been hanging around in the low 20s for the past few weeks.

Latest rankings: The table ranks each of the ten U.S. industrial sector iShares (ETFs) by our proprietary Outlook Score, which employs a forward-looking, fundamentals-based, quantitative algorithm to create a bottom-up composite profile of the constituent stocks within the ETF. In addition, the table also shows our 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. Bull and Bear are backward-looking indicators of recent sentiment trend.

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


1. Technology (NYSEARCA:IYW) remains in the top spot with an Outlook score of 86 this week, followed by Healthcare (NYSEARCA:IYH) at 75. Industrial (NYSEARCA:IYJ) scores about the same as last week, but a resurgence in Financial (NYSEARCA:IYF) pushed it down to fourth. Still, the rankings reflect a bullish bias, with the more economically sensitive sectors like Technology, Financial, Industrial, and Consumer Services all in the top five and having an Outlook score above 50.

2. Utilities (NYSEARCA:IDU) and Telecom (NYSEARCA:IYZ) remain in the bottom two. IDU is saddled with the lowest long-term growth rate, and IYZ has the highest (worst) forward P/E. With Consumer Goods (NYSEARCA:IYK) in the bottom four, we see that defensive sectors bunched at the bottom. Also, stocks within Energy (NYSEARCA:IYE) continue to be downgraded by the analysts.

3. Looking at the Bull scores, Basic Materials (NYSEARCA:IYM) and Financial (IYF) have been quite strong on strong market days, scoring 59. Utilities (IDU) is by far the weakest on strong days, scoring 41.

4. Looking at the Bear scores, Utilities (IDU) remains the investor favorite "safe haven" on weak market days, scoring a strong 68, followed by Telecom (IYZ). Materials (IYM) has the lowest Bear score of 43. Stocks within IYM have tended to sell off the most when the market is pulling back.

5. Overall, IYW now shows the best all-weather combination of Outlook / Bull / Bear scores. Adding up the three scores gives a total of 191. IYZ is the worst at 119. IDU and IYZ might be sitting at the bottom of the Outlook rankings, but these two reflect the best combination of Bull/Bear at 109. Consumer Services (NYSEARCA:IYC) now displays the worst combination of Bull/Bear with a 101.

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

Top-ranked stocks within Technology and Healthcare sectors include CalAmp (NASDAQ:CAMP), Innodata (NASDAQ:INOD), Questcor Pharmaceuticals (QCOR), and Auxilium Pharmaceuticals (NASDAQ:AUXL).

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