When Will Oversold Stock ETFs Revert Back To The Mean?

by: Gary Gordon

In the five-year bull market from 10/2002 through 9/2007, large-cap indexes typically carried price-to-earnings (P/E) ratios ranging from 17-18. Perma-bears harped on these “valuations” throughout the period, expressing 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 price tag for the S&P 500 not only reverted to the arithmetic mean, it had dropped into single digits by March of 2009.

Perhaps ironically, even as the stock market’s price clawed back during the 3/2009-4/2011 uptrend, P/Es did not keep up. Corporate profits were so strong for seven consecutive quarters, leaving P/Es for the S&P 500 in a subdued range of 11-13x trailing earnings.

Perma-bears 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 price on the S&P 500 is currently 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 perma-bears 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 MA (potentially oversold):

Q4 Candidates For Reverting Towards A Trendline (200-Day “Mean”)
% Below 200-Day EMA
iShares Latin America 40 (NYSEARCA:ILF) -16.8%
iShares All Country Asia Excl Japan (NASDAQ:AAXJ) -16.7%
Vanguard MSCI Emerging Markets (NYSEARCA:VWO) -16.0%
S&P SPDR Select Materials (NYSEARCA:XLB) -15.9%
Vanguard Financials (NYSEARCA:VFH) -15.3%
iShares MSCI Australia (NYSEARCA:EWA) -14.6%
iShares Russell Microcap (NYSEARCA:IWC) -14.3%
iShares MSCI Canada (NYSEARCA:EWC) -14.0%
Vaguard FTSE All-World (NYSEARCA:VEU) -12.8%
Market Vectors Agribusiness (NYSEARCA:MOO) -12.6%
Click to enlarge

Disclosure: Gary Gordon, MS, CFP is the president of Pacific Park Financial, Inc., a Registered Investment Adviser with the SEC. Gary Gordon, Pacific Park Financial, Inc, and/or its clients may hold positions in the ETFs, mutual funds, and/or any investment asset mentioned above. The commentary does not constitute individualized investment advice. The opinions offered herein are not personalized recommendations to buy, sell or hold securities. At times, issuers of exchange-traded products compensate Pacific Park Financial, Inc. or its subsidiaries for advertising at the ETF Expert web site. ETF Expert content is created independently of any advertising relationships.