ETF Expert

Since March of 2011, I have maintained more conservative portfolios for my clients than normal. There was no shortage of reasons. For instance, the uprisings throughout the Middle East meant higher oil prices. And the natural disaster in Japan meant disruptions to world trade.

Granted, stocks have a way of climbing the proverbial wall of worry. Yet stocks also tend to look 3-6 months ahead. With QE2 ending in June, and the possibility of a prolonged debt debate in D.C. during July and August, I continued raising my allocation to cash and income-producing assets in May.

The May-June swoon seemed to validate the decision. We witnessed a technical default for Greek bonds, extreme pressure on country debt throughout the European Union, and exceptionally dismal data on the U.S. economy.

Granted, corporate earnings in July were phenomenal. And that fact alone during the July earnings season kept the market near its April 2011 highs. But seriously, how much “bad news” could the market discount?

When the markets collapsed towards the 1100 level, I did make selective purchases. I still like the yield that comes from the energy pipeline partnerships a la JP Morgan Alerian (AMJ). I remain a steadfast supporter of Asian neighbors to China, particularly iShares Malaysia (EWM).

In addition, I may be nibbling at Apple via PowerShares QQQ. I may even be intrigued with more iShares High Yield (HYG) due to a widening spread between high-yield corporates and same duration treasuries.

Nevertheless, this rally that restored the S&P 500 back above 1200 is extremely suspect. While the odds of a recession may only be ”one in three,” the market at -11.5% off its April highs may not be fully pricing in a contraction in earnings.

In essence, here are 3 reasons to allocate a bit less to stock ETFs than you might normally allocate.

1. Across-the-board “Selling On Strength.”One of the healthier signs of a real rally — as opposed to a relief rally or dead-cat bounce — is the absence of investors selling into strength. However, investors seemed to relish the opportunity to take profits on Monday, 8/15/11. Investors sold $240 million of SPDR S&P 500 (SPY), $140 million of the Healthcare Select SPDR (XLV) and $90 million of Basic Materials (XLB).

Stock ETFs even comprised seven of the top 10 assets being sold into strength. Admittedly, the dollar amounts sold were not monumental. That said, I still see the pattern as indicative of a trading environ, not an investing environ.

2. A “Technical” Mess.The price of the CBOE Volatility Index (VIX) is above its 50-day and 200-day. Moreover, the 50-day trendline for the VIX rose above the 200-day in late July. You have similarly poor results with the price of S&P 500 SDPR (SPY) falling below its 200-day in late July.

It’s bad enough when volatility is elevated and major benchmarks — S&P 500, MSCI All World, MSCI Emerging Markets, MSCI EAFE — have all dropped below major trendlines. Yet there’s simply no sugar-coating the way that Dr. Copper feels. The metal with a Ph.D. in economics (via iPath Copper JJC) is dragging its heels near its 2011 lows.

3. Fundamental Chit-Chat. I am every bit as fond of fundamental valuation as the next. The difference? I do not regard P/Es, P/Bs and P/Ss in a vacuum. We can’t simply say that something is cheap when it can get much cheaper. We can’t ignore historical evidence, seasonal data, geopolitical factors, contrarian measures or central bank influence on interest rates.

Indeed, I’ll be one of the first people to point out that Microsoft has a better rating and a better yield than a downgraded 10-year treasury. Yet it doesn’t mean that the market’s ability to over-react to fear can be dismissed outright.

Bottom line? Nibble on the ETFs you covet during extreme fear, like when the S&P 500 is pushing new 52-week lows. Or wait for the sharks to leave the water. Since we’re no longer pushing new lows, and the sharks are still circling, watch those toes.

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