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ETF Safety Is In The Eye Of The Beholder

18 June 2012 at 11:31 am by Gary Gordon     Bookmark and Share    Follow EtfExpert on Twitter

If you tune out¬†the noise — Spanish bond yields, Greek elections, U.S. job weakness, China “hard landing” — simplicity can guide intelligent investment decisions. Here are 3 potential ideas for¬†ETF enthusiasts:

1. Safety In Emerging Market Sovereign Debt. For example, emerging market sovereign bonds are clearly better than comparable U.S. Treasuries. We can debate European contagion risk until we are blue in the face. Yet the iShares Barclays 7-10 Year Treasury Bond Fund (IEF) is distributing 1.85% annually whereas Powershares Emerging Market Sovereign (PCY) is delivering 5.25%.

The reality that the Fed and the central banks of the world endeavor to create inflation (a.k.a “reflation”) only make things less attractive for the safe haven darling of U.S. government debt. Traders may try to eke out a bit more capital appreciation from IEF. That said, PCY provides 3.4% more yield and the collective debt-to-GDP ratio for the emergers in PCY versus the same ratio for the U.S. or for Europe will soon redefine the concept of bond safety. (Note: PCY is also dollar-hedged, reducing the currency risk associated with today’s “strong dollar.”)

2. Below 10 P/Es In Foreign Markets. It’s true that I have virtually no equity exposure to foreign stock ETFs. Without a “black swan” opportunity, I am not going to buy or hold onto¬†assets that fall below and stay below 200-day moving averages. (Note: Review the commentary at this link to understand the¬†way in which I protect ETF portfolios¬†with stop-losses, hedges and¬†non-correlated assets.)

VWO 200

That said, emerging markets (particularly China) represent the engine of global growth. Were it not for a dependency on exports to Europe, would emerging stocks via Vanguard Emerging Markets (VWO) really trade at a price-to-earnings discount of 26% when compared with Vanguard Total U.S. Stock Market (VTI)? How about VWO trading at a 24% price-to-book discount when compared with VTI?

Granted, true value seekers are not content with P/Es of 11 like VWO. That’s why¬†you may want to dig a little deeper in your quest. State Street S&P China (GXC) recently reported a P/E of 9.3, WisdomTree India Earnings (EPI) last reported a P/E of 9.8 and¬†Global X FTSE Argentina (ARGT) at 9.5. (Note: Again, I am not making “buy now” recommendations.)

ARGT 200  

3. High Yield Corporates Hedge Against Inflation.¬†¬†As much as the gloom-n-doomers¬†(and the Fed) discuss the painful effects of¬†deflation, there’s no denying the fact that¬†the U.S.¬†Consumer Price Index (CPI) has annualized at 2.25% over the last 5 years. The¬†“Great Recession” may have destroyed net worth as well as wage growth, but¬†“stuff” still costs more. Perhaps ironically, CPI does¬†not really account for¬†soaring health care¬†and college costs.

So what’s needed? In my estimation, one needs a¬†covert hedge against¬†the¬†erosion of purchasing power. With iShares Barclays 7-10 Year Treasury Bond Fund (IEF)¬†currently distributing 1.85%, iShares High Yield Corporate Bond (HYG) and its annual distribution of 7.35% is a spectacular hedge. Normally, the¬†yield spread is around 4%, but the 5.5% spread over comparable treasuries¬†means that IEF could lose badly on rising interest rates/rising inflation¬†while HYG¬†would likely hold¬†firm¬†until the norm is restored.

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Disclosure Statement: ETF Expert is a web log (‚ÄĚblog‚ÄĚ) that makes the world of ETFs easier to understand. 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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