It seems that every Tuesday in 2013 since January 8 has been positive
on the Dow. And this past Tuesday was no exception. Now that sounds
like a trend to put money on — buy the SPDR Dow Jones Industrial
Average ETF (DIA) at the close each Monday and close out the position
late on Tuesday.
The Dow and S&P 500 both hit new all-time highs once again on
Wednesday, while the Nasdaq hit its highest level since November 2000.
The “risk on” allocation of new investment capital into cyclicals
continues, although Wednesday saw leadership from defensive sectors
Consumer Staples, Utilities, and Telecom, along with Financials.
Nevertheless, ConvergEx reports that the average correlation of the ten
S&P business sectors to the overall index averaged 82% last month.
While that is below the 86% average of the past few years, it is still
quite a bit higher than what we expect of a “healthy” market.
Investors have been climbing a “wall of worry” by focusing on their
Silver Linings Playbook. And there’s little doubt that the silver
linings are growing more prominent. The US economy is improving while
unemployment is falling. Bank balance sheets are solid while
corporations enjoy historically high levels of cash, and they are
deploying their cash for stock buybacks and acquisitions. Most retail
investors are still on the sidelines with cash at the ready, and they
are starting to show an appetite for equities. Housing is displaying
sound footing as demand and prices both rise. Increasing asset values of
homes and stock portfolios are creating a wealth effect that is
spurring consumer spending.
Furthermore, corporate earnings have been growing, but there has not
been much top-line growth as businesses have been reluctant to expand,
choosing instead to rely upon cost-cutting and increased productivity.
However, confidence in the global economy and increased consumer
spending should eventually get them to start hiring again.
Another positive for the long-term health of the global economy is
the boom in North American oil and gas production (primarily related to
shale and oil sands, as well as to the impact of new technologies on
extraction from mature fields). As the US gradually moves toward the
Holy Grail of energy independence, it would remove a major obstacle to
growth that the “peak oil” doomsayers have been predicting. North
America’s emerging competitive advantage with respect to energy costs is
already starting to result in the on-shoring of manufacturing, reversing a troubling trend and giving hope to US job-seekers.
Of course, the Fed’s combination of near-zero Fed funds rate and
quantitative easing has kept the yield curve both low and flat, thus
pushing return-hungry investors into riskier assets like equities. But a
big driver of this year’s sustained market strength has been the
stabilization of sovereign debt in Europe, with Spanish and Italian bond
yields falling from around 7% last year all the way down to around 4%
today. And now Japan is reporting that its economy grew faster than
anticipated during Q1, as consumer spending and exports rose in response
to the country’s aggressive monetary and fiscal stimulus. This is all
comforting news for investors.
Moreover, the US Congressional Budget Office now predicts a 2013
budget deficit of only $642 billion (4% of GDP), which is more than $200
billion below its February estimate, and is far below the $1.4 trillion
deficit (10% of GDP) of 2009 and last year’s deficit of $1.1 trillion.
The CBO now forecasts the 2015 budget deficit to fall to $378 billion
(2.1% of GDP).
By the way, Sabrient’s “Baker’s Dozen” top 13 stocks for
2013 closed Wednesday up +22% since its inception on January 11. (Over
the same timeframe, the S&P 500 is up +13%.) The portfolio’s
performance is led by EPL Oil & Gas (EPL), Alaska Air Group (ALK),
Genworth Financial (GNW), and Air Lease (AL). However, all 13 positions
are positive, and 11 of them are up by double digits.
One of the keys to portfolio performance is avoiding meltdowns, and Sabrient’s proprietary Earnings Quality Rank (EQR)
has been an important screening factor in the quant model that
underlies the Baker’s Dozen selection process. EQR is a pure
accounting-based risk assessment signal that was developed in
conjunction with Sabrient subsidiary Gradient Analytics, a renowned
forensic accounting research firm. On a scale of 1-5, with 5 the best
(lowest risk), this year’s Baker’s Dozen portfolio reflects an average
EQR of 4.2.
Looking at the chart of the SPY, it closed Wednesday slightly above
166. After closing Tuesday right at the upper line of the bullish rising
channel that has been in place since November, Wednesday saw some minor
weakness before bulls took the reins and pushed through the upper line.
Still, oscillators like RSI, MACD, and Slow Stochastic are more
overbought than they were last week, price is far extended beyond its
moving averages and due for a reversion to the mean, and Bollinger Bands
have grown inordinately wide. I expect price to pull back into the
channel for some further technical consolidation before we see a
concerted breakout.
The CBOE Market Volatility Index (VIX), a.k.a. “fear gauge,” closed
Wednesday at 12.81, which is quite low and confirms bullish conviction.
It has been not been above 20 at any time during 2013.
Latest rankings: The table ranks each of the ten
U.S. business 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. The multi-factor model considers forward
valuation, historical earnings trends, earnings growth prospects, the
dynamics of Wall Street analysts’ consensus estimates, accounting
practices and earnings quality, and various return ratios. 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. Consumer Goods (IYK) takes over the top spot from Financial
(IYF) with an Outlook score of 77, but the top three remain essentially
in a dead heat, with IYF scoring 74 and Technology (IYW) scoring 72.
Stocks within IYK continue to enjoy growing support from insiders and
Wall Street an analysts (i.e., net upgrades in forward earnings
estimates) and strong return ratios, although valuations (P/Es) are
getting high. IYF displays strong sentiment among insiders and Wall
Street analysts, as well as a low forward P/E.
2. Telecom (IYZ) stays in the cellar with an Outlook score of 4. It
is weak in forward P/E, long-term projected growth, and return ratios,
although it enjoys good Wall Street support. It is joined in the bottom
two again this week by Basic Materials (IYM), which is seeing a
continued acceleration in Wall Street earnings downgrades.
3. This week’s fundamentals-based rankings appear to have slipped
to a neutral or even slightly defensive bias, with defensive sectors
Consumer Goods (IYK), Healthcare (IYH), and Utilities (IDU) in the top
five.
4. Looking at the Bull scores, IYK has been the surprising leader
on particularly strong market days, scoring 54, followed closely by IYF
at 53, while IYZ and IYW have been the laggards on strong market days,
scoring 48. The narrow top-bottom spread has further tightened to only 6
points, which continues to indicate high sector correlation on strongly
bullish days.
5. Looking at the Bear scores, Utilities (IDU) is still serving as
the favorite “safe haven” on weak market days, scoring 62, followed
closely by IYZ at 61, while Materials (IYM) is the worst during extreme
market weakness as reflected in its low Bear score of 43. The top-bottom
spread is 19 points, which continues to indicate lower correlations on
weak market days, i.e., it pays to be in the safe sectors when the
market is bearish.
6. Overall, Consumer Goods (IYK) shows the best all-weather
combination of Outlook/Bull/Bear scores. Adding up the three scores
gives a total of 186. Telecom (IYM) is the worst at 113. Looking at just
the Bull/Bear combination, Utilities (IDU) and Healthcare (IYH) both
display an impressive total score of 110, followed closely by Telecom
(IYZ) and Consumer Goods (IYK) at 109. Materials (IYM) displays by far
the lowest score at 92. This indicates that Utilities and Healthcare
stocks have performed the best in extreme market conditions (whether
bullish or bearish) while Materials stocks are avoided altogether.
These Outlook scores represent the view that Consumer Goods and
Financial sectors may be relatively undervalued, while Telecom and Basic
Materials sectors may be relatively overvalued based on our 1-3 month
forward look.
Some top-ranked stocks within IYK and IYF include V.F. Corp (VFC),
Ingredion Inc. (INGR), Markel Corp (MKL), and The Howard Hughes Corp
(HHC).
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 aggregate 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 1-3 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.
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