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How Low P/E ETFs Can Become Less Risky

Stocks in this article: AFK EWZ SPY GXC SCZ IWM

NEW YORK ( ETF Expert) -- 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 ratio of U.S. stocks is greater than 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 theyve already refinanced at ultralow 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 2013s domestic exchange-traded fund 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.

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