When Will 'Oversold' ETFs Revert to the Mean?

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) -- In the five-year bull market from October 2002 through September 2007, large-cap indices typically carried price-to-earnings ratios ranging from 17 to 18. Permabears harped on these "valuations" throughout that period, saying that major benchmarks had not reverted back to a historical average of 15.

With the real estate lending bubble bursting in dramatic fashion, stock assets plummeted 40%. Separately, the P/E for the S&P 500 not only reverted to the arithmetic mean, it had dropped into single digits by March of 2009.

Perhaps it's ironic that even as the stock market's price clawed back during the March 2009-April 2011 uptrend, P/Es did not keep up. Corporate profits were strong for seven consecutive quarters, leaving P/Es for the S&P 500 in a subdued range of 11-13.

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Permabears have ignored this reality. Instead, they've chosen to focus on what they call "unrealistic corporate expectations." (They've been saying it for several years now.)

Granted, companies may not beat expectations at a 70% clip this earnings season. Obviously, CEOs will guide lower with the extreme economic uncertainty ahead. That said, if the collective guidance for S&P 500 corporations is lowered to a mere 3% growth in profits for 2012 ... the S&P 500 would need to trade at 1500 by year-end 2012 to revert to a historical P/E average of 15. (Note: The S&P 500 is at 1160.)

I'm not here to argue that the market is overvalued or undervalued. The stock market is worth exactly what it's worth on the day you're staring at it. That said, I am suggesting that permabears often use different facts to maintain a permanently pessimistic bias.

Me? I am neither bullish nor bearish. I know that markets can be irrationally spiritless as well as irrationally exuberant. By the same token, I offer a variety of reasons for allocating more or allocating less to riskier market-based securities.

At this moment, I am still weighted more heavily toward income production and cash. Yet I am definitely mindful of the fact that many indicators -- P/Es, rolling returns, shorter-term "technicals" -- may revert to a historical average. What's more, when it happens, stock prices should move significantly higher.

Although I touched on P/Es, it may be worth looking at a tendency for prices to revert toward a 200-day trendline. Here then are 10 popular ETFs that are more than 10% below a 200-day moving average (potentially oversold):
Q4 Candidates for Reverting Toward a Trendline (200-Day 'Mean')
% Below 200-Day EMA
iShares Latin America 40 (ILF) -16.8%
iShares All Country Asia Excl Japan (AAXJ) -16.7%
Vanguard MSCI Emerging Markets (VWO) -16.0%
S&P SPDR Select Materials (XLB) -15.9%
Vanguard Financials (VFH) -15.3%
iShares MSCI Australia (EWA) -14.6%
iShares Russell Microcap (IWC) -14.3%
iShares MSCI Canada (EWC) -14.0%
Vanguard FTSE All-World (VEU) -12.8%
Market Vectors Agribusiness (MOO) -12.6%

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Disclosure Statement: ETF Expert is a Web site that makes the world of ETFs easier to understand. Gary Gordon, Pacific Park Financial and/or its clients may hold positions in ETFs, mutual funds and investment assets mentioned. The commentary does not constitute individualized investment advice. The opinions offered are not personalized recommendations to buy, sell or hold securities. At times, issuers of exchange-traded products compensate Pacific Park Financial or its subsidiaries for advertising at the ETF Expert website. ETF Expert content is created independently of any advertising relationships. You may review additional ETF Expert at the site.

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