If You're a Bull, What Do You Buy Now?

StreetAuthority Network

The S&P 500 index is now about 4% off its all-time intraday high of 1,687.18, which was made on May 22. That's a big drop in a little over two weeks, especially when you consider that this level of pullback didn't happen during the whole fiscal cliff debacle, or even during the much-feared sequester cuts.

Over the past couple of days, I've been hearing rumblings that this market sell-off just "feels different" from past pullbacks. The catalyst for this change in market attitude comes courtesy of the Federal Reserve and the recent chatter around "tapering" quantitative easing, or QE, possibly as soon as September.

The fear over Fed tapering has caused many traders I've spoken with recently to suspect this could be the beginning of the first real correction in more than six months.

If you buy into this premise and are bearish in the short term, then there's no question about what you should do. Basically, you should sell now, take your winnings off the table, and then wait until the dust settles before making any new bets.

The tougher question is what to do now if you're a bull.

For an answer to this perplexing situation, I turned to one of my favorite market consultants, Tom Essaye, editor of The 7:00's Report. Tom is one of the few bona fide market geniuses that I know personally, and his advice and counsel never fail to get me thinking about things in new ways.

According to Tom, "Economic growth remains the key to whether this is a correction or trend change. Right now, there is a growing consensus opinion that because the economy is consistently growing, albeit slowly, that the Fed will simply have to taper QE in September or risk igniting large asset bubbles."

As we've seen from the recent volatility in the bond market, and of course, via the big spike in long-term Treasury bond yields, the bond market already is preparing for the Fed to pick up its easy money ball and leave the playground. I also suspect that is why this correction just feels different.

Still, if you are a bull, and if you are shopping around for great trades, then there are a few key concepts you need to keep in mind.

First, you will want to be buying value here, which means you should look at sectors that have been beaten down significantly during the past several weeks. Second, if you are a bull then you probably also are optimistic about continued economic growth. What this means is that you will want to look at the beaten-down market sectors that tend to do well when the economy is growing, and that means cyclical stocks such as basic materials, commodity producers and even mining stocks.

If you have some risk capital here, and if you are willing to stick your neck out on the bullish thesis, then there are a couple of exchange-traded funds (ETFs) that could provide you with some serious upside over the course of the next six months.

Materials Select Sector SPDR (XLB)

This fund is what I call the quintessential basic materials play, as it holds the biggest names in the sector, including Monsanto (MON), DuPont (DD), Dow Chemical (DOW) and Freeport-McMoRan (FCX).

When the economy grows, this fund is likely to do well. Moreover, the recent pullback to the 50-day moving average means you can get in on this fund at what is potentially a very attractive entry price.

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XLB Chart

Recommended Trade Setup:

-- Buy XLB at the market price
-- Set stop-loss at $36.51, approximately 8% below the current price
-- Set initial price target at $47.63 for a potential 20% gain in six months

Market Vectors-RVE Hard Assets Producers ETF (HAP)

This fund holds companies that produce the basic materials an economy needs to function. Top holdings in HAP include Exxon Mobil (XOM), Deere & Co. (DE) and Archer-Daniels Midland (ADM).

Technically speaking, this fund now trades well below both the 50-day and 200-day moving averages. If fact, HAP isn't too far from its 52-week low, which could make it an incredible value if the bull thesis is correct.

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HAP Chart

Recommended Trade Setup:

-- Buy HAP at the market price
-- Set stop-loss at $32.35, approximately 8% below the current price
-- Set initial price target at $42.10 for a potential 20% gain in six months

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