How Do You Know When An ETF Is Actually A Bargain?

Includes: IEZ, XLU
by: Gary Gordon

Jack Hough recently wrote an “Ahead of the Crowd” article for Barron’s on finding value in the stock market. The author cited a Merrill Lynch study that looked at core fundamental data dating back 25 years — data like book value, cash flow and earnings — to determine overpriced and under-priced sectors.

My first reaction to reading the piece was to wonder why so many recommendations are built on price-to-book (P/B) and price-to-earnings (P/E) ratios alone. If the investing public should have learned anything over the last 15 years, it’s the reality that fear and greed may be the most important drivers of market activity. That’s why contrarian info, as well as technical data, matter.

As an information processing advocate, I would not stop there. There are seasonal factors, geopolitical influences, oil price fluctuations, interest rate decisions, macroeconomics, fiscal policy decisions… all of which carry different weights at different times.

Granted, the earnings yield of the S&P 500 at 7% looks mighty attractive when the 10-year Treasury bond is at 2%. There’s more to the story, though. The benchmark has moved up to a 5-year high at the same time that the 10-year yield has jumped nearly 50 basis points. In other words, evaluating one piece of info while ignoring other contributing factors is foolhardy.

(Ask a fundamental analyst how well his assessment worked prior to the 2008-2009 financial collapse. Better yet, ask the former helmsman of Legg Mason Value how well a deep discount value model worked in the banking crisis.)

Cheap can always become cheaper… a lot cheaper. High-priced can always go on to be exceptionally high priced. In fact, there is rarely widespread agreement on reasonable prices for growth, income, safety or a combination of those components.

It follows that the Merrill Lynch study (or should we more accurately say, Bank of America study) places a high-price tag on real estate investment trusts and utilities. Bargains? Software and energy equipment.

By most fundamental measures, Utilities (NYSEARCA:XLU) have been overpriced for 3 years. That hasn’t stopped folks from buying. The truth is, the biggest danger to XLU would be additional price deterioration in Treasury bonds. Absent that, XLU will continue to provide income and safety.

Energy equipment has been a bargain for the last 2 years. In actuality, I like the segment based on technical, fundamental, seasonal and economic info. That said, iShares DJ Oil Equipment and Services (NYSEARCA:IEZ) is at the higher end of its Relative Strength Index (RSI) range. I might be more intrigued by a 5% pullback.

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.

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