Indicator of the Week: 2 Sectors to Watch for Contrarian Traders

The outperforming Machinery Tools sector is bathed in skepticism, while optimism surrounds the underperforming Drugs sector

by Rocky White

Published on Mar 9, 2016 at 7:30 AM
Updated on Mar 9, 2016 at 7:30 AM

Most readers are probably at least somewhat familiar with our contrarian philosophy at Schaeffer's Investment Research. In essence, we look for stocks that are moving higher, yet the investing crowd seems to be very pessimistic about (or vice versa when looking for stocks that could move lower). The pessimism is a signal that there are a lot of potential buyers who could be won over for a particular stock, while the increasing stock price is the catalyst that can win over these traders. When this large pool of investors start moving their money into the stock, it can push the stock a lot higher in a relatively short amount of time. This week, I will look at some simple indicators to evaluate sectors based on this philosophy.

Best Sectors and Stocks: To rank the sectors, I looked at the stocks within each sector and combined their short interest and analyst buy/sell/hold recommendations that we get from Zacks. A high amount of short interest and a low percentage of "buy" recommendations indicate a lot of pessimism in the stocks. That's the sentiment part of the score. I also averaged the six-month and 12-month returns of the stocks within the sectors, which make up the price action part of the score. Considering the sentiment and price action of the stocks within the sectors, I then ranked the sectors from best to worst.

The table below shows the best ranked sectors along with some figures. These are sectors which have better-than-average price action and evidence of a very pessimistic investing crowd. I highlighted the Machinery Tools sector as one that stands out with good price action this year, yet only 27% of the analyst recommendations are a "buy."    

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Below are the stocks in the Machinery Tools sector that have a positive year-to-date return and show some signs of pessimism -- including analysts' percent "buys" below 50% and a Schaeffer's put/call open interest ratio (SOIR) above 1.00.  This would make a good initial stalking list for someone looking to buy stocks.

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Worst Sectors and Stock: Naturally, I did a similar analysis looking at sectors that have performed poorly, yet for some reason have garnered optimism from investors. I thought the Drugs sector was interesting, and listed below some stocks that contribute to its poor sector ranking.

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Here are stocks from the Drugs sector that are down year-to-date, yet have more calls than puts among options expiring in the next three months (as indicated by a SOIR below 1.00), and more than half of the analysts have a "buy" recommendation on the stock. If investors capitulate and unwind these bullish bets, then it could send these stocks even lower. 

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