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Courtesy of Scott Martindale, Sabrient Systems and Gradient Analytics
The “risk-on” trade seems to be hanging tough as more than a passing fad. Risk-off means that money is flowing into safe havens like U.S. Treasuries and solid currencies like the U.S. dollar and Swiss franc; whereas risk-on means that money is flowing into more speculative assets like equities, commodities, emerging markets, and higher yielding currencies. Perhaps investors have grown weary of low bond yields and the incessant chatter about impending financial Armageddon. Now that riskier assets have shown that they can hold support levels, new money is slowly but steadily showing up for the party. Slow is good.
For 2011, the Barclay’s U.S. 20-year Treasury Bond Fund (TLT) was up about +28%, while the SPDR S&P 500 Trust was up only +2%. However, the more speculative indexes didn’t fare so well. The Nasdaq was down -1.8%, the Russell 2000 small cap was down -5.5%, and the MSCI Emerging Markets Index was down a whopping -22%.
But so far this year (through Thursday), emerging markets, Nasdaq, small caps, and commodities have led the way—with the emerging markets index up about +9.2% and the SPDR Gold Shares (GLD) is up +7.2%, while the TLT is down -2.2%. Among the 10 sector iShares, Basic Materials (IYM) is up nearly +10% this year already. This week in particular, the emerging markets index pulled away from the pack, while the leading sector iShares have been Technology (IYW) and Consumer Services (IYC).
SPY closed Thursday at 131.46. The chart looks like it could keep rising for awhile. That’s what happens when it doesn’t give us too much all at once. RSI, MACD, and Slow Stochastic all could stand to cycle back down, but nothing says it needs to happen today. Still, a little pullback and technical consolidation would be welcome as a new buying opportunity. SPY has surpassed its October highs and will likely take a run soon at its 52-week highs from last May, near 137.
One caution is that daily trading volume remains low, which means that price can move quickly in response to any major disruption or news flash. But so long as earnings reports continue to be mostly good and economic reports tend toward the positive, this market sure seems to have support.
The VIX (CBOE Market Volatility Index—a.k.a. “fear gauge”) closed Thursday at 19.87, which was down nearly 5% on the day and puts the VIX below strong support at the 20 level. This is bullish for stocks as it indicates a lack of investor fear—i.e., risk on.
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) is finally turning back down from resistance at the 60 level. It closed Thursday at 52.56. Although it still indicates elevated investor worry about bank liquidity and a preference for the safety of Treasuries bonds over corporate bonds, this marks a potential trend change that would further bolster the risk-on trade.
In case you missed it, Sabrient’s annual “Baker’s Dozen” Top 13 Stocks for 2012 were unveiled on January 5 in a free live WebCast. Sabrient’s founder and chief market strategist David Brown was the main speaker, and Luke Rahbari of Stutland Volatility Group offered up his suggestions on how a trader might execute options trades on some of the names on the list. The full report and video replay are now available:
http://www.sabrient.com/individuals/Bakers-Dozen-2012-Signup.html
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, quantitative 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. 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.
Observations:
1. Technology (IYW) and Healthcare (IYH) remain at the top of the Outlook rankings, but they switch places this week. IYH is back on top with an Outlook score of 83—still above the 80 mark, which I consider important for the top-ranked stock in order for the relative rankings to be predictive. (When the scores are bunched together at lower values, it indicates to me indecision and uncertainty about which sectors will be the leaders.) IYH has been particularly strong in maintaining analyst positive sentiment, while IYW is particularly strong in its return ratios and also sports a solid (low) projected P/E.
2. Energy (IYE) and Basic Materials (IYM) sport low projected P/Es and the highest projected long-term growth rates, apparently investors still think the analysts are too optimistic, even with the ongoing downward earnings revisions. The fact that IYE and IYM both rank below 50 might reflect a perception that the dollar will continue to strengthen against the euro.
3. Telecom (IYZ) holds its position ahead of Consumer Services (IYC), but these two still dwell at the bottom of the rankings. IYZ remains saddled with the highest projected P/E, while IYC is burdened by tight margins and low return on sales.
4. Looking at the Bull scores, IYM has been the leader on strong market days, scoring 60, followed by Financial (IYF) and IYE. IDU is by far the weakest on strong days, scoring a 32.
5. As for the Bear scores, IDU is the investor favorite “safe haven” on weak market days with a score of 66, followed closely by IYH. IWM, the strongest on bullish days, displays by far the lowest Bear score of 41, which means that stocks within this ETF sell off the most on weak market days. Interestingly, only three of the sector iShares (IYM, IYF, and IYE) have Bear scores below 50. However, IYF has been slowly but methodically climbing in its Bear score, from 38 several weeks ago to 48 this week, as the sector finds more and more investor support.
6. Overall, IYH displays the best combination of Outlook/Bull/Bear scores. Adding up the three scores gives a total score of 189. IYC is the worst at 117. IYH and IYJ tie for the best combination of Bull/Bear with a total score of 106, while IDU has the worst combination at 98, despite its top Bear score.
Top ranked stocks in Technology and Healthcare include Seagate Technology (STX), Apple Inc. (AAPL), Momenta Pharmaceuticals (MNTA), and United Therapeutics (UTHR).These scores represent the view that the Technology and Healthcare sectors may be relatively undervalued overall, while Consumer Services and Telecom 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 sector.
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.
