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Low P/E ETFs Become Less Risky When They Boast Technical Uptrends

Many value-oriented stock pickers do not see a self-sustaining U.S. economy and they continue to play “Taps” on their trumpets. Commonly cited warning signs include: (1) The 10-year annualized price-to-earnings (P/E) ratio of U.S. stocks is above 25, (2) In absolute dollar terms, the amount of borrowed money (i.e. margin debt) in the stock market has never been higher, and (3) Corporations bought back stock with debt that they’ve already refinanced at ultra-low interest rates, and now they are hoarding cash rather than spending it on equipment, innovation or human resources.

For fundamental and technical reasons, I have been shifting a modest amount of client assets into foreign ETFs with verifiable uptrends. That said, I cannot help but notice that many of the same U.S. biases remain intact. Specifically, here in early January, investors are still bidding up the prices of 2013’s domestic ETFs winners rather than opt for underappreciated assets that may represent overseas opportunities.

2013 Superstars Are Still Shining In 2014
Approx 5 Day % Approx 1 Year %
SPDR Biotech (XBI) 10.7% 51.9%
PowerShares Pharmaceuticals (PPH) 2.9% 33.7%
iShares DJ Regional Banks (IAT) 2.6% 34.5%
iShares DJ Aerospace (ITA) 2.3% 55.0%
Global X Social Media (SOCL) 2.0% 61.2%
S&P 500 (SPY) 0.2% 28.2%
iShares MSCI Australia (EWA) -0.5% -0.4%
iShares MSCI All-Country Asia (AAXJ) -1.5% -3.6%
iShares MSCI Canada (EWC) -1.6% 1.6%
Vanguard Emerging Markets (VWO) -1.8% -10.4%
iShares MSCI S&P Latin America (ILF) -3.1% -20.3%

So far, it does not seem to matter that SPDR S&P China’s (GXC) Forward P/E of 10.2 makes it nearly 40% “cheaper” than the S&P 500 SPDR Trust (SPY) and its Forward P/E of 16.7. Even if emerging markets are frightening, developed regional markets also boast significant P/E discounts. On a trailing 12 month basis, iShares MSCI EAFE Small Cap (SCZ) is 25% less expensive than the iShares Russell 2000 U.S. Small Cap Fund (IWM).

Certainly, one would think that a shifting of the tides is inevitable. Optimistically, one would have to anticipate that domestic stock ETFs slow down relative to price gains for foreign stock ETFs. Pessimistically, a bear might maul equities of all stripes, failing to provide shelter for those who chose to sift through the bargain bin.

So how might you protect yourself? For starters, you must recognize that cheap can always get cheaper. You could have purchased the Nasdaq 100 (QQQ) 60% off of its 120 high at a price point of 50 in 2001, yet that would not have prevented further downside of another 60% as QQQ dropped from 50 to 19 over the remainder of the 2000-2002 bear. Stop-limit loss orders can help one minimize the possibility of cheap turning into a disaster. Similarly, resolving to purchase assets that have established intermediate-term (100-day) and/or long-term (200-day) technical uptrends also increases the probability that you are making a well-reasoned decision.

For instance, Market Vectors Africa (AFK) has a trailing 12-month P/E of 12. Is it a bargain? Is it less risky than the name itself might otherwise dictate? Perhaps. The current price is not far from where it was a year ago. The price is also above both its 100-day as well as its 200-day moving average. Moreover, the 100-day recently crossed above the 200-day, a phenomenon that many technical analysts believe to be quite bullish.  On a P/E of 12 alone, I would not be inclined to consider this exchange-traded tracker. With its recent price movement, however, I’d have greater confidence in this fund’s capital appreciation potential.

AFK 100 200

In contrast, a number of estimates place the Forward P/E for iShares MSCI Brazil (EWZ) at 11. That might be considered a steal at a 33% discount to the S&P 500. Yet from my vantage point, the recent inability of EWZ to hold either its long-term (200-day) trendline and/or its intermediate-term (100-day) trendline are reasons enough to look elsewhere. Efforts to catch a falling knife rarely pan out.

EWZ 100 200

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