Courtesy of Scott Martindale, Senior Managing Director
The Energy Sector has demonstrated a surge in technical strength to lead the market higher this week, and at the same time it has surged in the SectorCast rankings.
Despite continually flashing severely overbought signs and the need for a healthy correction, the bulls are giving the bears no quarter whatsoever. Friday, Monday, and Tuesday each saw the SPY threaten to break down through its uptrend line, but the 20-day moving average lent support to the uptrend line, and today we saw the SPY breakout through overhead resistance at 127.50 to close the day at 128.58.
Powered by the Fed and a dearth of bears (who might be hibernating), the market has been on a steady upward path since the first of December. At some point it will break below the uptrend line and pull back more significantly — to at least the 20-day moving average and perhaps to the lower Bollinger Band. Of course, it has to happen eventually. The only question is how much further it will climb before the inevitable correction.
Note that MACD has flatlined near overbought. The RSI(14) was signaling that it wanted to work off its overbought condition and head for the neutral line, but now it has turned back up. Price has been hugging the upper Bollinger Band. All of these signal a need for a pullback. An examination of the chart shows that the SPY was able to remain between the upper Bollinger Band and the 20-day moving average for 2 1/2 months during the September-to-mid-November timeframe, and today we are barely into the second month of the current pattern.
A few times over the past week, SPY gave the test of the 20DMA that I had been anticipating, but there was no breakdown. It’s all setting up much like it did in early November, before the correction to the lower Bollinger Band.
If that pattern intends to repeat, this might be the “blow-off top” I predicted last week, which would precede a correction. But with everyone awaiting a pullback for a new buying opportunity, it might be a quick and shallow one that gets bought up quickly (like we saw in November).
The market volatility index (VIX) closed today at a low 16.24, 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 low within its normal range, coming in at 16.11. Both indicators are relatively low and still reflect complacency (and investor optimism).
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 virtual portfolio for a given set of anticipated market conditions.
Technology (IYW) again holds the top spot with a strong Outlook Score of 86. Healthcare (IYH) is still in second with an 83. These two have consistently scored at the top as their performance hasn’t outrun reasonable valuation and analyst expectations. Defensive sector Consumer Goods (IYK) strengthened further this week from 56 to 60, but remains distant third.
Telecommunications (IYZ) is once again in the cellar with a 17, as the U.S. Telecom companies just don’t show much in the way of compelling growth or projected valuations. Basic Materials (IYM) strengthened somewhat this week at the expense of Consumer Services (IYC), which has over-performed and needs a pullback, according to the fundamentals-based quant model. So IYC joins IYZ in the bottom two this week with a score of 31.
Energy (IYE) strengthened considerably this week in the rankings, jumping from sixth place to a tie for fourth with Financial. Notably, its price performance led all sectors, as well. It appears that analysts have been coming out in support of Energy lately.
Looking at the Bull and Bear scores, Basic Materials (IYM) and Financial (IYF) have tended to perform the best in recent periods of overall market strength, while not surprisingly Consumer Goods (IYK) and Utilities (IDU) have held up the best on weak market days. Technology (IYW) seems to boast the best overall combination of the three scores. It has consistently scored near the top of the Outlook Score, but its Bull Score has been average during this bull run, which is why it continues to show good relative valuation.
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. IYH continues strong in return on equity and return on sales, and it has the lowest (best) projected P/E.
Top ranked stocks in Technology and Healthcare include Jabil Circuit (JBL), Kulicke and Soffa (KLIC), The Medicines Co. (MDCO), and Skilled Healthcare Group (SKH).
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 Leap Wireless (LEAP), Crown Castle International (CCI), Amazon.com (AMZN), and Coldwater Creek (CWTR).
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.
