3 Reasons for Caution on Stock ETFs

The following commentary comes from an independent investor or market observer as part of TheStreet's guest contributor program, which is separate from the company's news coverage.

NEW YORK (ETF Expert) -- If you've been a longtime reader, you know that I regularly call out "permabull" or "permabear" thinking. I don't believe that it is sensible to listen to a financial adviser who always sees the glass as half full or follow someone who always sees the glass as half empty.

At the same time, I actively manage money for my clients -- I am not a static asset allocator. And that means I must make information-based decisions about the percentage of riskier assets to hold. Specifically, I make changes to the asset allocation when there is an abnormally high level of downside risk or when upside opportunities arise.

For example, I might reduce a moderate growth portfolio down from a 65% growth/35% income allocation to 40% growth/45% income/15% cash. In contrast, there may be times when I bump up the moderate growth target allocation from "65%/35%" to "72%/28%."

As an active manager of exchange-traded investments, I use a wide variety of ETF indicators to make my decisions. And while those choices may make me seem more "bullish" or "bearish," I'm less apt to describe myself as a member of either camp.

More accurately, my chief responsibility is to minimize the risk of loss. Exchange-traded stock index funds take care of their upside performance quite well, but they won't get you out of a jam by themselves. Active stewards of risk, however, control investment outcomes. They make certain each outcome is either a big gain, a small gain or a small loss ... no big losses!

It follows that, in light of the staggering five-day market upswing of 5.4% in the S&P 500 recently, perspective is warranted. Specifically, here are three reasons why stock ETF investors might want to refrain from jumping back into the shark tank with both feet.

1. Significant Underperformance for Emerging Markets. It's one thing to view emerging-market volatility as "too much" for a low-risk portfolio. It's another thing to see emerging markets fall further on the downside, yet barely rise on the upside.

Granted, some of this is due to the recent safe haven seeking of dollars over Asian and other emerging-market currencies. What's more, emerging markets may have more at stake in a potential European recession.

Nevertheless, the price-to-earnings ratios for many key ETFs, from the SPDR BRIC ETF (BIK) to the iShares South Korea Fund (EWY), are surprisingly low in relation to U.S. exchange-traded index funds. And the performance gap is wider than at any point over the last year. (See the chart below.)

In many instances, these are healthier economies with superior growth prospects, low debt, trade surpluses, low unemployment and a leash on inflation. It follows that, until emerging markets rally convincingly, it's difficult to have confidence in the sharp U.S. equity move higher.

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