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Three ETFs to Buy Before the Post-Rally Sell-Off

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Risk of capital fleeing the markets seems high.

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With the equity markets 40-45% above where they were in March, and the memories of the September 2008-March 2009 collapse fresh in investors' minds, the speed at which capital could exit the market at the first signs of new risk is high.

One of the potential new risks is the escalation of the foreign policy challenges facing President Obama from North Korea to the Middle East. With the banking system reliquified and the economy starting to show some of the intended benefits of the stimulus packages, now we have another set of international issues that, coupled with the overbought situation, could cause investors to remove capital from harm's way.

1. iShares Barclays 20+ Year Treasury Bond ETF (TLT)
Trades that could benefit from equity "de-investment" include the TLT. Treasuries have become acutely oversold in the last 4 months -- a reflection on interest rates backing up for fear the government would have to sell increasing amounts of Treasuries to pay for its programs, as well as on investors' demand for a higher-risk premium.

However, last week, the day after a very disappointing 10-year T-bond auction, prices reversed strongly to the upside and have been climbing since. When there is uncertainty, in this case internationally, and investors flee to quality, where else are you going to go but into Treasuries? That's still the safe haven, still the currency of choice. Gold is not performing as well as many had hoped, which reinforces that the dollar is still the world's reserve currency, and those dollars are in short supply globally, which is especially evident during times of crisis.

In just the last few days, The TLTs have gone from about 88 to 92.5, a move of about 5%. Applying a bit of creativity, we can find a near-term bottom formation that looks conspicuously similar to, but opposite from, the patterns in gold and the euro/dollar.

As the dollar has gained on the euro, and gold has sold off, the TLTs are looking stronger, with an optimal upside target zone in the vicinity of 93.5-94. At this juncture, only a sudden plunge that violates 90.30 will delay but not derail the current setup.


Click to enlarge.

2. ProShares UltraShort SPY (SDS)
Another trade that's overdone in one direction is the S&P 500 and its SPDR ETF (SPY). The S&P 500 was up 43% until a few days ago, and in the past 3 days has fallen nearly 5%. That shouldn't be surprising, as we've seen a 2-week period at the end of this big up leg, where volume has been tailing off measurably, and the advance-decline figures have shown weakening breadth.

We appear to have a near-term peak right around where the 200-day moving average is, with a number of technical indicators suggesting the SPY is exhausted and due at least for profit-taking. Profit-taking could turn into a deeper retracement of the March-June advance if investors react much more swiftly than at any time in recent memory to heightened risks impeded in the ongoing uncertainties of domestic eco-politics, compounded by new international challenges.

To participate in the downside, I like SDS, which since last Tuesday has thrust from the 51.5/20 area towards my next optimal target in the vicinity of 57. Only a break below Tuesday's late-session pullback low at 55.85 will trigger initial signals that the up leg from the June 11 low at 51.55 to the 57 area is complete, and that a correction's already in progress.

3. US Oil Fund ETF (USO)
Similar to the S&P 500 is the 4-month pattern in USO, which climbed from the 22 to 40 area, or 82% from February to June, suggesting technically that a bear-market rally may also be ending for oil. To relieve its overbought condition, the USO could retreat into the 34 to 32 area. I wouldn't be surprised if it broke down and headed back toward 22, or, in the case of crude oil futures, down to the $36 to $33 area over the next few months.
No positions in stocks mentioned.
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