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Note: The following is an excerpt from the ETF Spotlight newsletter, which can be downloaded here. It was prepared with data from the ETF Analyzer PREMIUM app on Seeking Alpha.

Your humble analyst has deep personal connections in Japan and like most people is deeply saddened by the tragedy still unfolding there. The seven Japan ETFs we cover sold-off sharply over the past two days before recovering some lost ground by the close of trading on Tuesday.

However we have to caution investors against bargain hunting as none of the funds have a high ALTAR Score, our measure of an ETF's overall investment merit. It was clear even before the disaster hit that sales growth for Japanese firms was anticipated to slow dramatically (chart below). In fact, the roughly 3-4% growth rate anticipated for this year is slower than for any other broad ETF we cover (see page 4 in the newsletter). Now add to that the disruption to the economy--not just consumers but also production--and the outlook is obviously bleak.

Chart: Japan ETFs

Annual Sales Growth, 2011E versus 2010


(Click to enlarge)

We can't quantify the impact of the earthquake/tsunami on Japanese profits, but the export-oriented multinationals in the iShares MSCI Japan fund (EWJ) may be able to cope fairly well. However the fact is that Japanese firms have relatively low levels of profitability anyway, so despite trading at relatively cheap valuation multiples compared to other developed markets (even before the disaster sell-off) the stocks still do not appear to represent a bargain.

That said, we favor these large caps over smaller firms such as those in the iShares MSCI Japan Small Cap fund (SCJ). Consider a pairs trade: long EWJ/short SCJ.

Table: Ticker, Name & ALTAR Score of funds in above chart

Ticker Name ALTAR Score
JPP SPDR Russell/Nomura Prime Japan 5.0%
EWJ iShares MSCI Japan 5.1%
ITF iShares S&P/TOPIX 150 5.0%
SCJ iShares MSCI Japan Small Cap 3.1%
JSC SPDR Russell/Nomura Small Cap Japan 2.9%
DXJ WisdomTree Japan Dividend 5.8%
DFJ WisdomTree Japan Small Cap Dividend 4.8%
Source: Spotlight: Japan ETFs