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Courtesy of Scott Martindale, Senior Managing Director, Sabrient
The usual suspects of Materials, Industrials, Financials and Energy continue to lead this unstable market both up and down. Technology has been less volatile, and in fact it has been tracking closely with Healthcare lately. These two also happen to rank the highest this week in Sabrient’s SectorCast ETF rankings.
Last week, the Dow suffered its worst one-week performance in nearly three years — after the FOMC came out with a highly negative statement about the economy’s “significant downside risks,” including volatility in financial markets, high unemployment, depressed housing market, and cautious consumer spending.
However, Nicholas Colas of ConvergEx pointed out in his daily commentary that the average multiple for the 30 Dow stocks is 10.3x next year’s consensus earnings projections, which is historically low, and the average dividend yield is 2.6%. But he also points out that although corporate earnings have stayed strong and the Fed is doing everything it can to keep up the stimulus, the magnitude of expected earnings growth seems overly ambitious. Given all the global uncertainty, it is certainly understandable that many investors are reluctant to rely on analyst projections. And in fact Sabrient’s data is showing that analysts are gradually reducing their estimates.
The European financial crisis is getting hopeful signs but is still not yet resolved. European commercial banks hold plenty of sovereign debt from the PIIGS nations. But with the crisis in Greece, and the Greece 1-year bond still yielding a dire 131%, fears of default and a possible banking crisis abound. Europe is expected to create a plan similar to the 2008 U.S. TARP program in which $700 billion was injected into U.S. banks. A “Euro-TARP” is estimated to require $200 billion of capital to purchase distressed sovereign debt from the European commercial banks.
Optimism around this program supported the stock markets bounce this week through Wednesday morning, but ultimately it was a little too much too soon for many investors, who decided to lock in some gains.
One big winner on Wednesday despite overall market weakness was Sabrient favorite Jabil Circuit (JBL), up +8% after a stellar earnings report. Sabrient’s models give it a Strong Buy rating and an Outlook score of 98, Value score of 92, and Growth Score of 99.
Last week, gold began to get dumped in a big way. It appears that it was mostly a “risk-off” trade in which traders de-leveraged their positions — perhaps due to either margin calls or simple profit protection. I have commented that gold mining stocks have lagged the price run-up in gold bullion, partly due to the belief among equity investors that the price of gold price has reached an artificially and unsustainably high level. Now, rather than gold mining stocks rising to close the gap, the price of gold is falling rapidly. However, global uncertainties should keep a floor under gold prices at some level before too long.
Looking at the SPY chart, the channel between support at 112 and resistance at 122 held at support last week, and we got a bounce this week. Let’s see if it can ultimately breaking through resistance at the top of the channel. Support has already held three times. A fourth test might be forthcoming.
The VIX (CBOE Market Volatility Index – a.k.a. “fear gauge”) has elevated further from the mid-30s where it has seemed so content to close Wednesday at 41.08 – up +9% on the day. This is quite a bit higher than the teens it fluctuated in just months ago and reflects investor uncertainty.
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) continues to creep higher. It closed today at 36.35, and has been consolidating in this mid-30’s range. Although not nearly so high as it was during the 2008 financial crisis, it nevertheless indicates elevated investor worry about bank liquidity and a preference for the safety of Treasuries bonds over corporate bonds.
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.
Here are some observations about Sabrient’s latest SectorCast ETF scores.
1. Healthcare (IYH) remains on top with a solid Outlook score of 80. Healthcare is a growth sector within an aging population, no matter what the overall economy does. It has managed to maintain analyst support (on a relative basis) while other sectors are getting net reductions in earnings projections across the board. Materials (IYM) continues to get the bulk of the analyst downgrades.
2. Technology (IYW) returns to the second spot with an Outlook score of 75, as Energy (IYE) tumbled 26 points from 71 to 45. Analysts have been relatively supportive of stocks in the IYW. It has reasonably good scores on most of the model’s factors, particularly return ratios and long-term growth projections. Consumer Goods (IYK) has made its way to the third spot, scoring a 57, as the analysts have held their ground on the sector’s earnings expectations. IYK also carries the highest return on equity.
3. Consumer Services (IYC) and Telecom (IYZ) are back in the bottom two, as they now score a 26 and 15, respectively. Both are weighted down by weak return on sales (poor margins) and high projected P/Es. Industrial (IYJ) got a bounce out of the bottom two this week as the analysts weren’t quite so hard on the sector as they were the prior week.
4. Overall, the Outlook rankings are a little less conservative, as Industrial and Technology got a bit of a pop, but still defensive.
5. Looking at the Bull scores, Financial (IYF) and Industrial (IYJ) have been the leaders on strong market days, scoring 58, followed by Basic Materials. Utilities is the weakest with a 43.
6. As for the Bear scores, Utilities is the clear investor favorite “safe haven” on weak market days with a score of 68. Consumer Goods and Healthcare are tied for second at 61. Financial and Materials now reflect dismal Bear scores of 40, as they have led the market up on strong days and down on weak days.
Overall, Healthcare (IYH) displays the best combination of Outlook/Bull/Bear scores. Adding up the three scores gives it a total score of 188. Utilities (IDU) has the best combination of Bull/Bear with a total score of 111. Both of these are defensive signs.
Top ranked stocks in Healthcare and Technology include Jazz Pharmaceuticals (JAZZ), Perrigo (PRGO), Tech Data (TECD), and Apple (AAPL).
Low ranked stocks in Consumer Services and Telecom include Six Flags Entertainment (SIX), Corinthian Colleges (COCO), SBA Communications (SBAC), and Sprint Nextel (S).
These scores represent the view that the Healthcare and Technology 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 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.
