ETF Plays for Market at Crossroads of Optimism and Risk Aversion

2013 has been a good year for stocks. Despite the recent flattening and consolidation in the SPDR S&P 500 ETF (NYSEARCA:SPY) the large-cap index is sitting on gains of approximately 20% so far this year. Those impressive returns have been further eclipsed by the iShares Russell 2000 ETF (NYSEARCA:IWM) which has jumped more than 24% higher over the last seven months. Investors that casually glance at their 401(k) and brokerage account statements on a monthly or quarterly basis are more than likely impressed with these double-digit-percentage returns.

However, there is still a lot of game left to be played in 2013, and just about anything could happen. That is why it is important to consider both sides of the trade and have a plan in place to lock in gains if the rally decides to fizzle out or ride the tide higher if stocks keep running.

The bulls have been buoyed by the outperformance of small cap stocks as a sign of healthy demand for risk assets. The bears, on the other hand, are convinced that the market has been stretched like a rubber band and that it will snap back in a vicious correction. Several market technicians, including Jeff Saut, who I truly respect, have predicted a near-term top that would set up an excellent buying opportunity in the context of a secular bull market.

From a technical standpoint I can see the case for both a continuation of the rally or a potential pullback. Right now the momentum trade is still clearly intact, and trying to call a market top has been an exercise in futility. However, I believe the probabilities are sliding more toward a late summer correction and increased volatility that should be bought into with the expectation of a year-end rally. As with nearly every mature bull market, we should see a reversion to the mean (long-term trend line) that will work off some of the overbought momentum. This will create a better value opportunity for cash that is sitting on the sidelines to enter the market and resume the upward bias.

There are several key areas I am monitoring on a chart of the S&P 500 Index (INDEXSP:.INX) that will likely serve initially as points of support but can also provide you with risk management guidance as well. The first trip lower will likely coincide with 1,650, which is near the 50-day moving average. Breaching that mark will lead to speculation about support at the June low of 1,575 which the bulls will vigorously defend, as the next stop lower is the 200-day moving average at 1,530.

I am inclined to start putting money to work in stocks below the 1,550 level as I think this represents an attractive area of opportunity. That would represent a pullback in the broad market of approximately 8% and be in close proximity to the 200-day moving average.

I still believe that the best course of action will be to average into new positions in increments by using price to your advantage. Very few will be able to perfectly time a market correction and buy the absolute bottom, however there will be opportunities for buying weakness that will present better value than right here.

One area that I will be looking to allocate to on a pullback is defensive plays such as the iShares MSCI US Minimum Volatility ETF (NYSEARCA:USMV). This ETF contains a great mix of 133 low-volatility blue chip names with excellent dividend yields. The top-three holdings include: Johnson & Johnson ( JNJ ), General Mills ( GIS ), and Pepsico ( PEP ). I believe that USMV makes up an excellent diversified core equity position because of its focus on holding companies with historically low price fluctuations. In addition, the minimal 0.15% expense ratio makes it a very affordable solution for either growth or income portfolios. In fact, it may be just the perfect cross between bullish optimism and bearish risk aversion for your next investment opportunity.

Read more from David Fabian, Managing Partner at Fabian Capital Management:

Should You Consider Short ETFs for Your Portfolio?

Apple Inc. Boosts Tech ETFs, but Summer Rally May Be Waning

5 Defensive Funds to Guard Your Nest Egg

Twitter: @fabiancapital

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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