The ETFs to Buy in an Uncertain Market (And When Has It Been Otherwise?)

By Max Isaacman  APR 02, 2013 2:02 PM

A bad event in a stock can make the stock immediately go down. ETFs can be volatile, but less so.

 


The stock market’s advance has confounded pundits, investors, and observers, and brought a smile to those who are invested, and consternation to those who have pulled out or are waiting to get in. Many investors have been waiting to get into the market for some time. The market has climbed a wall of worry for years now, and gloom and doom commentators, many of whom were right in the past, keep forecasting a collapse. This might happen, the bears might eventually be right, but the risk of being on the sidelines has been costly, and the more the market moves into new high territory, the greater is the anxiety for those on the sidelines. Markets move to their own rhythms, and are impossible to talk down. 

There were many who were better buyers than sellers in the dark days around the time of the Lehman Brothers collapse, including myself. I remember one of the times I was asked my opinion back then. I got a call from a long-time client who had been vacillating about staying in the market, fretting that the market would keep going down and she would lose her money. She told me to sell her out, which I did, and I told myself, “This is the market bottom.” I had thought the market had bottomed before, but I was even more sure of it now. Not that I was smarter than anyone else, since there is no lack of smart people on the Street. I simply felt that people had to eat, that they had to find a way to make a living and, from the worker levels of CEOs to carpenters and laborers, people would adjust, work hard, and find a way to function and grow.

This is the American way, to work in a system that is relatively free, that is vibrant, and that is people-based, that is, people make the difference. Add to that that there is no economy to match the US, what with its global companies, many of them leaders in their field. This made it hard back then to be a seller of stocks, many of which had dropped to ridiculously low valuations.

If an investor had hung on back then, he would have his money back. The market is back around the old highs, judged by the S&P 500 Index (INDEXSP:.INX). It is true that we have real problems today, and it is always thus, but the benefits of our economic system are still there, people still have to eat, and equities are reasonably priced. Finding the equity classes that will outperform is harder now. Nevertheless, in spite of what we hear from the doomsayers, betting on America and the global economy makes sense if you can take the risk, especially when one of the few options is bonds, which are historically yielding very little.

This should be a good decade for stocks. In my book Investing with ETF Strategies (FT Press, 2012) I reviewed how stocks outperformed bonds in all 10-year periods since 1960 except for the 2000-2009 period. In that decade the performance is inverted and bonds outperformed stocks. A stock investor would have about broken even, and a bond investor would have made about 7.5% on average per year. In the last 100 years there have been short periods when bonds outperformed stocks, but over longer periods stocks have outperformed.

Almost every investment beat stocks over the last 10 years. Treasury bonds, silver, gold, platinum, oil, junk bonds – even the 10-year Treasury bill had a better return than the stock market. Investments have cycles and underperforming asset classes do not underperform indefinitely. Usually when people have given up on an asset class that is when the assets are selling the cheapest. History suggests it’s time for the stock market to outperform. ETFs to Consider

The nature of investing using exchange traded funds is different than investing or trading stocks. When investing and trading stocks there can be real surprises, good as well as bad. A bad event in a stock can make the stock immediately go down. ETFs can be volatile also, and large losses can occur. But ETFs are made up of many companies, and it would take a reversal of an entire asset class for all the companies in a class to be affected. Also asset class reversals usually take a length of time to occur, where with stocks a buy or sell event can take very little time.

The Nasdaq-100 (NASDAQ:QQQ) seems reasonably valued, selling at about 15 times earnings. A significant reason why QQQ hasn’t performed vs. the S&P 500 is because Apple (NASDAQ:AAPL) has gotten hit, and AAPL is a large part of the index, comprising about 12.6%. AAPL might be bottoming, selling at less than 9x earnings. Also AAPL could have upside surprises. It is estimated that US sales of Apple’s Mac computer increased by 31% in January 2013 when compared to January 2012. Also, although QQQ is comprised of about 12% AAPL, other companies are prominent in the index and could help QQQ’s performance. Microsoft (NASDAQ:MSFT) and Google (NASDAQ:GOOG) together comprise over 13% of QQQ. Both of these companies have performed fairly close to the S&P 500 year to date.

Another ETF to consider, although there is more risk, is the WisdomTree Emerging Markets Equity Income Fund (NYSEARCA:DEM). DEM pays a dividend of 3.38%, and sells about 11.5 times earnings, which is a reasonably low valuation. The risk is in the weighting of the index, which is comprised of about 30% in China and Russia, countries that might not perform. Global correlations have broken down as emerging markets have not participated in the global market rally. Emerging markets in 2013 have had their worst first quarter performance since 2008. This is the first time the sector has not outperformed the other countries during a bull market since 1998. An investor in DEM might have to be patient. Longer term investors have been rewarded with emerging markets investments, since the group outperformed the S&P 500 over the longer term.

Sentiment is not on the side of emerging markets. According to the March 2013 BofA Merrill Lynch Fund Manager Survey, managers have increasing confidence in the US dollar and US equities and decreasing confidence in emerging markets.   The highest level of dollar bullishness was registered in March, with 72% of respondents expecting the US dollar to appreciate over the next year. In January 2013, 19% of the respondents said they wanted to underweight the US vs. the latest survey in which 5% said they wanted to overweight the US, a 24% change in positive sentiment. Only 14% expect the China economy to be stronger than next year.

Of course, when sentiment is low buyers can buy low, and there could be upside surprises in the economic growth in the emerging markets.
 
Editor's Note: Max Isaacman is the author of Blizzard of Money, Winning with ETF Strategies, Investing with Intelligent ETFs, How to Be an Index Investor, and The NASDAQ Investor.
Positions in DEM and QQQ.