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Markets at New Highs: Two ETFs to Consider on a Pull Back!

by Mike Burnick on January 24, 2013

in Commodities, Stocks, Technical Analysis

Mike Burnick

Generally upbeat results so far this earnings season continue to propel stocks higher with the S&P 500 Index reaching a new post-credit crisis high above 1,485 to start this week.

Investors will be intently focused on fourth-quarter 2012 financial reports over the next few weeks, looking for clues about the future direction of stocks. With about four-fifths of S&P companies still due to report in the weeks ahead, it’s a bit too early to draw conclusions. But sales and profit trends look bullish so far.

Sixty-five percent of the S&P 500 companies reporting thus far have exceeded analyst estimates for earnings — and perhaps more importantly — 69 percent of firms are beating  sales forecasts.

Granted, the overall earnings growth rate still looks anemic, as was expected, with year-over-year profit growth of just 1.9 percent. Still, that’s a marked improvement from the prior quarter when S&P 500 earnings declined 1 percent year-over-year for the quarter ended September 2012.

Click the chart for a larger view.

This is solid evidence that the “trough” in corporate profit growth is behind us. But stay tuned for a rush of results this week and next when 51 percent of S&P 500 companies are scheduled to report.

Financial and technology stocks are posting some of the strongest results thus far in terms of positive sales and earnings surprises, with consumer stocks not far behind. By the first week of February, we should have a more complete picture of corporate sales and profit trends.

However, in spite of earnings-inspired new highs in the stock market, it’s a good idea to proceed with caution right now. And this has everything to do with sentiment.

Bullish Sentiment

on the Rise

Recently, Bloomberg reported that international investors are the most bullish they have been on stocks in more than three years, with close to 67 percent planning to boost their exposure to stocks over the next six months.

Also, according to Investors Intelligence data, only 22.3 percent of those surveyed last week were bearish on the market while 53.2 percent expressed a bullish opinion. While not yet at an extreme, the share of bearishness is not far above the 20 percent level associated with market corrections in the past.

There’s nothing like a 16 percent rally in the S&P 500 Index over the past 12-months to bring out the bulls in droves and send the bears into hibernation! But investor sentiment can prove fickle and is often pointing the wrong way at key market turning points, as I discussed last week about commodities.

It’s not that markets are destined to fall immediately just because bullish sentiment is on the rise, but many stocks and sectors look over-bought at the moment.

For instance, as this week began, over 90 percent of stocks in the S&P 500 Index were trading above their 50-day moving average, as you can see in the chart below.

Click the chart for a larger view.

That’s an extreme reading and a sign that this rally is extended and markets may need to at least pause to refresh for more gains ahead. In the past, we’ve seen corrections of 5 to 10 percent or steeper following such extreme readings.

To me, this counsels for caution despite positive profit surprises and new highs in many stocks. But whatever direction markets take near-term, the path of least resistance is certainly pointing higher for most asset classes longer-term.

That’s why I’m keeping a close eye on select energy, industrial and health care stocks and ETFs right now. These are the three top-performing sectors so far in 2013 — up more than 5 percent each — with energy and industrials posting the best gains last week.

Two ETFs you may want to consider, particularly after a short-term pull back, are the SPDR Energy Sector ETF (XLE) and the SPDR Health Care Sector ETF (XLV).

Good investing,

Mike Burnick

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