With only a few weeks of trading left before we close the books on 2017, we thought it would be of interest for our readers to look ahead to 2018 and evaluate each of the main sectors. Most of the domestic indices are at or near all-time highs and investor sentiment is reaching extremely optimistic levels. While the new highs are encouraging, the extreme bullish sentiment is concerning. When you combine these factors with the length of the current bull market, it would seem that a correction isn’t out of the question.
Using the Select Sector SPDR ETFs as proxies for nine main sectors, we were able to gauge technical performance as well as current sentiment levels toward each sector. For the third leg of the analysis stool, we had to improvise a little and used the average fundamental rankings for the ten largest holdings in each of the nine ETFs. This allowed us to rank each sector in six categories, two in each of the analysis styles: fundamental, sentiment and technical.
Before we go any further, we should note that based on the monthly overbought/oversold indicators, 10-month RSI and slow stochastic readings, seven of the sector ETFs are in overbought territory, consumer staples is close to overbought territory and energy is the only sector that isn’t anywhere close to being in overbought territory.
Consumer Discretionary- Rank #4
The Consumer Discretionary Select Sector SPDR (NYSE: XLY) ranked fourth of the nine in terms of its overall analysis rank. The XLY is tied for the worst sentiment rankings, meaning the optimism is a little too high from a contrarian viewpoint. The fund does rank in the upper third in terms of its fundamental rankings and it is second in the technical rankings. It is among those that are overbought, but we see on the monthly chart that it isn’t as overbought as it was in 2013-2014.
Consumer Staples- Rank #4 (Tie)
The Consumer Staples Select Sector SPDR (NYSE: XLP) is tied for fourth in its overall ranking. The XLP does well in terms of the sentiment rankings, ranking second of the nine. This reflects a certain amount of pessimism toward the sector and as a contrarian this can allow the sector to reverse and rally more rapidly if the bearish crowd shifts over to the bullish crowd. The fund ranks fourth in terms of the technical indicators and as was mentioned earlier it is one of only two funds that aren’t in overbought territory based on the monthly oscillators. Where the XLP lags behind is in the fundamental portion of the equation as the fund ranks seventh out of nine.
Energy- Rank #9
The Energy Select Sector SPDR (NYSE: XLE) ranks last of the nine for its overall situation right now. It is in the bottom portion of the rankings in all three categories. It ranks seventh in the sentiment category, eighth in the technical category and sixth in the fundamental category. It is interesting that within the two fundamental stats, it ranks in the upper half for earnings growth, but ranks dead last in terms of profit margin, return on equity and sales growth (those three are combined in to one grade). As I mentioned earlier, one thing the XLE has going for it is that it is the only one of the nine that isn’t anywhere close to being overbought.
Financials- Rank #7 (Tie)
The Financial Select Sector SPDR (NYSE: XLF) ranks tied for seventh out of the nine overall. It is tied for last with the consumer discretionary fund in terms of the sentiment. It has the lowest short interest ratio of the nine and its put/call ratio is tied for eighth. The fund has done well on the technical front and in fact it ranks number one in that category. Unfortunately it ranks eighth in the fundamental category. When you look at the overall picture, it seems that the optimism and buying pressure are outpacing the fundamental performance of the sector. It is also worth mentioning that the current reading on the 10-month RSI is close to where it was in 2007 before the financial crisis.
Healthcare- Rank #2
The Healthcare Select Sector SPDR (NYSE: XLV) ranks number two overall and that is mainly due to the fact that it doesn’t rank in the bottom third in any category. The XLV ranks in the top third in sentiment and fundamentals while ranking in the middle third in the technical category. The fund ranks third in sentiment, third in fundamentals and is tied for fourth in technical performance. The 10-month RSI on the XLV is well below the high levels seen in 2013, 2014 and 2015. It is also worth mentioning that it just reentered overbought territory in May. The fund moved in to overbought territory in June ’12 and stayed there until August ’15.
Industrials- Rank #4 (Tie)
The Industrial Select Sector SPDR (NYSE: XLI) is tied with the consumer staples sector for fourth in the overall rankings. The XLI epitomizes average when it comes to the rankings in all three categories, it doesn’t rank high in any and it doesn’t rank low in any. It ranks sixth in the sentiment category, third in the technical category and fifth in the fundamental category. The recent sector rotation that has seen the industrial sector among the top three performing sectors over the last month and a half certainly helped lift the XLI in to that third spot in the technical category. Unfortunately the XLI holds the distinction of being the most overbought fund of the nine based on its 10-month RSI reading. The reading of 90.17 is the highest reading since the fund was launched in December of 1998.
Materials- Rank #3
The Materials Select Sector SPDR (NYSE: XLB) ranks third overall. The XLB was among the top performing sectors over the first ten months of 2017, but has been below average over the last month and a half. The fund doesn’t rank in the top three in any category, but it also doesn’t rank in the bottom three in any category. It ranks fifth in sentiment, tied for fifth in technical performance and fourth in the fundamental category. The XLB does have the highest short interest ratio, which ranks as the highest of the bunch and is the best from a contrarian viewpoint, but it is tied for the second lowest put/call ratio which is a sign of optimism and cancels out the high short interest ratio.
Technology- Rank #1
The Technology Select Sector SPDR (NYSE: XLK) ranks as the best overall fund of the nine based on my three-pronged approach. The XLK was far and away the best in the fundamental category as it has the best EPS rankings and the best in the profit margin, return on equity and sales growth category. It ranks fourth in sentiment thanks to the second highest put/call ratio of the nine. The fund lagged a little in the technical performance, but that is likely due to the recent performance. Like the materials sector, the tech sector has been caught up in the recent sector rotation and not in a good way. Through the first ten months of the year, the tech sector was the best performer of the nine. Since the beginning of November, the fund ranks sixth.
Utilities- Rank #7 (Tie)
The Utilities Select Sector SPDR (NYSE: XLU) is tied with the XLF for seventh overall. The XLU actually ranks number one in the sentiment category with the highest put/call ratio of the bunch and the short interest ratio is the second highest. Unfortunately it ranks last in the technical performance and the fundamental performance. Given that we are in one of the longest bull markets in history, it isn’t surprising to see the XLU lagging in the technical category. However, having it come in last in the fundamental category was a little surprising. The group ranked last in EPS growth and seventh in the other fundamental indicator.
There you have my predictions that are based on a mathematical, three-pronged approach that includes fundamental, sentiment and technical analysis. I see the top performing sectors of 2018 being tech, healthcare and materials. Oddly enough, those were the three top performing sectors for the first ten months of 2017 until the sector rotation started last month.