3 ETFs To Buy On A Market Pullback

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 |  Includes: DES, DXJ, EWJ, FXY, XLF
by: Matthew D. McCall

The Dow is hitting new all-time highs, the S&P 500 is 1.5% from joining the Dow, and the NASDAQ is at the best level in over a decade. All signs point to a strong bull market, however even the strongest of bull markets do not go straight up.

For well over a month the consensus among my colleagues has been that the market is due for a 5%-10% pullback. That has not occurred and I am not too certain a pullback of that magnitude will take place in the near future. Therefore, investors must be prepared to buy into the market if there are a few days of selling in anticipation of higher prices in the coming months.

The key is to be prepared to buy when the selling occurs because it will likely be short and sweet and if you hesitate the opportunity may pass you by. I have combed through my list of potential buy candidates and came up with four ETFs that should be poised to move higher after a normal and healthy pullback in price.

WisdomTree Small Cap Dividend ETF (NYSEARCA:DES) tracks a dividend-weighted index that is composed of almost entirely small cap stocks. The ETF recently hit its best level since 2007 and is up an impressive 10% in 2013. If the market rally continues the small cap stocks should be able to continue their run towards new highs as money looks for more aggressive investment options. An added bonus is the current yield of 3.3%. The ETF is heavily invested in the financials and industrials. Diversification is another positive for DES because the largest holding only makes up 2.1% of the entire allocation. A pullback in the $54 to $55 level would be ideal.

SPDR Select Sector Financial ETF (NYSEARCA:XLF) has not had a losing day in the month of March and is now at its best level since 2008. The ETF is a basket of the largest names in the financial sector with the three largest holdings being JPMorgan Chase (NYSE:JPM), Berkshire Hathaway (BRKA), and Wells Fargo & Co. (NYSE:WFC). I believe the only way a market rally continues is if the financials are on board for the ride higher. If this theory is correct the financials have more upside in the coming months. There is risk associated with the financials by the way of Europe, the U.S., and even China. However with low valuations, XLF trades with a P/E ratio of 12.58, and the potential to increase leverage the risk is mitigated to an extent. The support area for XLF is $17.50 to $17.75 and the level to watch on a pullback.

WisdomTree Japan Hedged Equity ETF (NYSEARCA:DXJ) has become a fan favorite in the last few months as the Japanese stock market has broken out and the Japanese Yen has taken out new lows. What makes DXJ so unique, and the only ETF of its kind, is that it gives investors exposure to the Japanese equities market and at the same time hedges against a drop in the Yen. To prove the importance of hedging the Yen we can compare the performance of the DXJ to the iShares MSCI Japan ETF (NYSEARCA:EWJ) since the start of December 2012. While DXJ is up 29% in the short period of time, EWJ has only gained 13%. This is because the Yen, as measured by the CurrencyShares Japanese Yen ETF (NYSEARCA:FXY), is down 14% in that timeframe. Japan does not appear to be set to stop it's "weak Yen" policy and therefore the same trend should continue with the Yen falling in value and Japanese equities rising. Due to such a parabolic move on DXJ I am looking for a deeper pullback and initial support is at the $41.50 area.

Conclusion

Buying on pullbacks has always been a strategy I have implemented when entering new positions. That being said, the one issue I have with waiting for a pullback is that when everyone is looking for a pullback, it rarely happens. The last few weeks are a great example of the pullbacks not transpiring. But over time patience will win out and that is why I have prices for the three ETFs below their current valuation.

Disclosure: I am long JPM, DES. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.