ETF Expert

U.S. stocks had a blockbuster month, as the S&P 500 garnered roughly 7.2%. However, the overwhelming majority of the benchmark’s gains came in the first 3 weeks; the index was effectively flat over the last trading week in July.

Fundamentally, a bullish perspective makes the most sense over the intermediate term. As many as 78% of S&P 500 corporations have exceded earnings expectations, while 68% or more beat revenue projections. Moreover, in spite of widespread economic uncertainty, a solid majority of key companies increased their outlook for future profitability.

How might this guide stock price direction? The forward price-to-earnings ratio for the U.S. stock barometer hovers near 13; that suggests a stock market that is… historically speaking… 20% undervalued from an average ratio of 15.5. The earnings yield E/P of 7.7% is an astonishing 4.7% higher than a 10-year treasury and 6.7% higher than comparable TIPS.

Technical analysis produces a markedly different picture. Specifically, the S&P 500 has yet to make a convincing breakout above its 200-day moving average. In fact, many believe that if it does not break through S&P 1113 soon, a sell-off would be inevitable.

Another bone of contention is the CBOE Volatility Index (VIX). It has closed below 25 for two straight weeks… a positive. However, VIX volatility needs to close below and remain below its 200-day trendline for technical/program traders to feel comfortable about taking on more risk.

It’s difficult to imagine U.S. stocks gaining enormous traction in the near-term. Mid-term elections in November might point to Republican seat “wins” and increasing gridlock… a positive. Yet 2010 uncertainty over tax policy may just keep U.S. stocks from getting too far ahead of themselves.

Should you be dismayed? Not really. Extreme downside risk appears limited, in light of the likely outcome of the mid-term elections, cash-rich corporations performing remarkably well, low inflation, low interest rates and falling 3-month LIBOR rates.

What’s more, emerging market growth is very robust. Technical uptrends exist for most emerging country ETFs, particularly those from Asia and Latin America. The broad-based Vanguard Emerging Markets (VWO) also shows a definitive pattern of “higher lows” since May… as well as a break-out above the 200-day trendline.

My ETF approach remains the same; that is, combine a broad-based Emerging Market ETF like Vanguard Emerging Markets (VWO) for a commitment to resource-rich BRIC (e..g, Brazil, Russia, India, China). Then complement the broad-based ETF investment with low-volatility neighboring countries like Malaysia (EWM) and Chile (ECH).

U.S. ETF investing needs to be a bit more oriented to income. Consider investments like the JP Morgan Alerian Energy MLP Note (AMJ) or iShares S&P Preferred (PFF), with yields north of 6%.

The PowerShares S&P 500 BuyWrite Fund (PBP) is another way to get income from “covered call writing” within the exchange-traded fund itself. The buy-write methodology limits upside growth potential but, more importantly, it reduces downside volatility in an uncertain economic environment.

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