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2 ETFs to Buy Before the Market Recovers

The exchange-traded fund universe is going through some changes as investors migrate to and from various ETFs in search of performance amid a hyper-reactive market.

Since just before earnings season started, some of the relative strength-leading ETFs like the SPDR S&P Retail ETF (NYSE:XRT), Consumer Discretionary Select Sector SPDR (NYSE:XLY) and Technology Select Sector SPDR (NYSE:XLK) have surrendered their status as leading investments. While the shaky short-term outlook for stocks might have some looking for refuge in cash, we think there’s potential for strong performance within the widely traded ETFs.

You just have to know what to look for.

Our database tracks the number of companies in ETFs that are posting new highs. The logic is simple: An ETF with a high ratio of new highs to new lows is showing breakout strength. The reverse is true in terms of ETFs that are breaking down.

No surprise, but during the past month the number of stocks making new highs has declined dramatically. And that puts the spotlight on a few heavy ETFs with a heavy percentage of new six-month highs:

First on our list is the SPDR KBW Insurance ETF (NYSE:KIE).

The insurance market has been heating up as the fundamental improvements among these companies have been driving higher prices. Companies like Allstate (NYSE:ALL), Progressive Insurance (NYSE:PGR) and Cincinnati Financial (NASDAQ:CINF) have seen improvements in their revenue and earnings results, helping to fuel some interest in the insurance sector’s outlook.

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The technical picture for KIE shares has been impressive, as the ETF is trading well above its 50-day moving average with a strong momentum trend in place.

The analyst community is starting to take note of the performance in the KIE companies, and we’re starting to see upgrades among these companies. Given the fact that the majority of the companies in the ETF are currently ranked relatively low by the analyst community, there is a lot of potential for upgrades within the group — meaning the upside potential for the KIE is strong.

As always, we checked the short interest on KIE shares for signs of pessimism. As far as ETF trading goes, KIE shares carry a high short-interest ratio, recently measured above 16. This indicates the current pace of outperformance is likely to spark some short covering, which would be bullish for KIe.

All in all, we like that the SPDR KBW Insurance ETF is starting to gain attention from the analyst community, as it suggests the crowd is starting to move into this outperforming ETF.

Next up: homebuilders.

Unless you’ve been stuck in a cave for the last three months, you’ve heard the buzz about the improvements in the housing and homebuilding sectors. One ETF near the top of out “New High” list is the SPDR S&P Homebuilders ETF (NYSE:XHB). With 19% of the XHB companies making new six-month highs, this ETF is among the top in upwardly mobile ETFs and likely to power higher into the year’s end.

Improvements in the housing market and the fact that the Fed is now buying mortgage-backed securities — a sort of “Bernanke Put” on the industry — suggests that the fundamental picture should continue to feed strong price action.

Strong earnings results among XHB’s holdings have investors (and analysts) sniffing around for opportunities. Instead of buying a few of these companies, however, we like the lack of company-specific risk afforded by investing in the XHB.

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Speaking of companies in the Homebuilders ETF, most people think the XHB is constructed of companies that only build houses. In fact, the majority of the XHB companies are retailers that are tied to the housing market, including Pier One (NYSE:PIR), Williams-Sonoma (NYSE:WSM), Lowe’s (NYSE:LOW) and Home Depot (NYSE:HD).

We love the diversity of the ETF as it provides us exposure to some retail companies — another group that should benefit from improvements in the economy. Watch for XHB to break toward the $30 level as 2012 approaches.

As of this writing, Johnson Research Group did not hold a position in any of the aforementioned securities.

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