The most common reason cited for P/E contraction in 2011? The Euro Zone debt crisis.

Obviously, sovereign debt concerns have not disappeared in 2012. That said, will its impact be as dramatic over the current 12 months as it was in the prior 12 months? Maybe not.

Let’s consider the possibility that investors are beginning to feel that Europe’s “situation” is already being discounted by the markets. In this scenario, we would likely experience P/E reversals; that is, the S&P 500 and its individual economic sectors could conceivably revert back to the P/Es that existed on 1/1/2011. 

Using the S&P 500 as a guide, current estimates for profit growth in 2012 are for a less robust 10.2% earnings expansion. If the S&P 500 reverts back to its P/E ratio price tag from the start of 2011 — with 10.2% profit growth in 2012, 15% growth in 2011, and 0% price gain in 2011 – one might expect a 25.2% gain for the S&P 500.

Is a 25.2% gain for the S&P 500 reasonable? Perhaps.

If the S&P 500 logs a 25.2% gain in 2012, it will reach 1573 – smack near the October 2007 all-time highs. On the surface, hitting or reaching the October 2007 highs may sound like a big deal. However, the December 2012 P/E would be far lower than the October 2007 P/E… still making stocks much cheaper than they were 5 years earlier. 

Of course, these numbers are for the S&P 500 as a whole. What if we applied the same P/E reversal thinking to the 9 S&P Sector Select SPDR ETFs? What might a respective Sector ETF gain (or lose) by the end of 2012, if we make the same assumptions about reverting to the price-to-earnings ratio of 1/1/2011.

Notice that each of the 20%+ returns come from the economically sensitive cyclical segments — Materials (XLB), Energy (XLE), Technology (XLK), Financials (XLF) and Industrials (XLI). Intuitively, this is not difficult to comprehend. The 2011 leaders came from the defensive segments, like health care, staples and utilities.

It follows that the only realistic shot for P/E reversion to occur in 2012 is for the global economy to find itself in increasingly better shape by the end of the year. If China begins to stimulate its economy through monetary and fiscal easing, if Europe gets beyond the notion of multiple Euro Zone defaults, and if the U.S. can continue to make muddle-through strides in the right direction, we may indeed get the super-sized gains out of the cyclical Sector ETFs.

Is 41% out of SPDR Select Materials (XLB) realistic? It has already claimed 9% out of the 2012 gates, better than the other segments.  Ironically enough, XLB registered 43% in 2009.

On the other hand, the P/E ratio hardly represents an exact science. For example, utilities may be slightly overvalued, but we have entered a period where yield may be every bit as important to he investor as capital appreciation. A slow-growth sector doesn’t necessarily have to fall -14.6% because its multiple is a bit higher than the historical average; rather, the earnings yield of 6.85% and dividend yield of 3.85% may be the perfect risk-reward scenario for conservative investors who want more from money markets or paltry treasury yields.

Keep in mind, I am not recommending that one make a whole-scale shift out of defensive equities and into cyclical sectors like Energy (XLE) or Technology (XLB). In fact, I have plenty of income-oriented positions from diversified high yield to MLPs to dividend producers; indeed, I still expect faith-shattering volatility in the 1st half of 2012. By the same token, it’s important to point out that P/E reversion is a distinct possibility and that… if it happens… higher-beta, riskier sectors may thrive.

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Disclosure Statement: ETF Expert is a web log (”blog”) 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. You may review additional ETF Expert disclosure details here.

Yet during the summer of our discontent — when technology shares plummeted alongside double-dip recession fears — Buffett loaded up on International Business Machines (IBM). He now owns more than 5% of ”Big Blue.”

Clearly, Buffett sees value in certain technology corporations, particularly one that has suffered alongside the broader market over the past 13 years. Yet he also used the seasonal tech slump to his advantage.

In the chart below, get a gander at the performance of the iShares DJ Tech Sector Fund (IYW) as it relates to the SPDR S&P 500 Trust (SPY). The relative strength in tech began to slip in April, as the 50-day trendline for IYW fell below the 200-day trendline. In contrast, the 50-day trendline for IYW reclaimed superiority in September; currently, it is not far from its greatest outperformance over SPY on the year.

Perhaps ironically, Warren Buffett acquired his hankering for IBM shares throughout Q2 and Q3. Ostensibly, Buffett began his binge in April and finished eating by September… almost assuredly winning with a “buy lower” seasonality decision.

And it’s not like shares of IBM were going for book value. Instead, Buffett likely demonstrated an obvious awareness of tech sector patterns before he decided to become one of Big Blue’s most important shareholders.

Historically, tech should prosper in its most powerful period (November-December-January). Yet hiccups in the Eurozone have already created some difficulty for the broader technology proxies like the iShares DJ Tech Sector Fund (IYW). The month-over-month results below suggest that Italian woes or Greek tragedies could easily derail seasonality and earnings.

You can listen to the ETF Expert Radio Show “LIVE”, via podcast or on your iPod. You can follow me on Twitter @ETFexpert.

Disclosure Statement: ETF Expert is a web log (”blog”) 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. You may review additional ETF Expert disclosure details here.

In theory, if we no longer need to fret the collapse of the EU — the solvency of member nations, the functionality of its banks, etc. – investors should be able to return to corporate earnings. And most should like what they see in the overall scheme of things — profitability, reasonable debt levels, revenue growth and plenty of cash.

That said, current trends still suggest a more cautious equity posture. Specifically, I checked two basic criteria in a recent screening: (1) Non-Bond ETFs that are less than 10% off 52-week highs and (2) Non-Bond ETFs with prices that climbed above a 100-day simple moving average. The first criterion intended to capture ETFs that were no longer in a “10% correction” mode; the second criterion sought to identify a bullish signal with the current price rising above an intermediate-term trendline.

There were about 45 ETFs that made the cut. Taking the screen one step further, I wanted to view only those ETFs that made the top quartile in relative strength percentile rank. In essence, these are the funds across the field of 1300 that may have the best momentum.

Roughly 25 ETFs cleared the last hurdle, forming 3 clusters: (1) Defensive Equity ETFs, (2) Higher-Yielding Equity ETFs and (3) Tech/Biotech ETFs. I’ve listed the assets in the groups below.

You can listen to the ETF Expert Radio Show “LIVE”, via podcast or on your iPod. You can follow me on Twitter @ETFexpert.

Disclosure Statement: ETF Expert is a web log (”blog”) 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. You may review additional ETF Expert disclosure details here.

Other media darlings don’t care what happens in a shorter period. They may run with a particular theme for decades. For instance, Jim Rogers likes commodities and the China growth story, irregardless of the bumps that may occur along the path.

Sometimes, the hottest 3-month winners are the same investments that fit a longer-term premise. For example, in 2009 as well as in parts of 2010, commodities and commodity-rich nations benefited from U.S. government decisions that weakened the U.S. dollar. Those that believe in the dollar’s demise over the long-term profited in shorter-term periods as well as year-over-year periods.

Some longer-term themes fall on deaf ears. The notion of cheap P/Es and an aging baby boomer demographic didn’t help healthcare-related stocks in 2009 or 2010; healthcare-related stocks severely underperformed in year-over-year periods as well as longer-term time frames.

Interestingly enough, healthcare has rocketed year-to-date. Pharma ETFs and Biotech ETFs even look pretty sharp over the last 12 weeks, showing tremendous relative strength.

Some of the more popular themes with corresponding ETFs have struggled in the recent 3 months. For instance, small-cap growth assets experienced a remarkable 12-month ride on the idea that the U.S. economy is recovering and can continue to grow on its own. With U.S. economic indicators from housing to unemployment to consumer sentiment worsening, however, small-cap growth has had its difficulties over a 3-month time period.

Similarly, energy and materials stocks dominated the 1-year timeline on the theme of increasing demand in the developing world. Yet they’ve had difficulty building momentum in the near-term due to emerging market credit tightening and questions about demand out of austerity-struck Europe.

In contrast, the most recent victors have been the non-cyclical ETFs (e.g., staples, utilities, etc.) as well as Japan ETFs on a “bounce-back” from an earthquake-induced economic contraction. Moreover, if 3-month momentum is to be recognized as an indication of what is likely to outperform in the near-term, one might stubbornly conclude that we are in the latter stages of the current bull market.

Of course, there’s no reason to adhere to momentum or to long-term themes alone, as some of your best laid plans will be decimated. Manias from dot-com to alt energy to nanotech have been losing propositions.

Indeed, one may lay the foundation for his/her portfolio on themes that resonate. For example, I have been emphasizing the key roles that Asian neighbors play in China’s growth for years, advocating ETFs like iShares MSCI Malaysia (EWM), iShares MSCI Singapore (EWS) or iShares MSCI Thailand (THD). Yet I’m equally cognizant of shifts in momentum. For that reason, I will incorporate investments with momentum, particularly those producing income like SPDR Select Utilities (XLU).

In other words, your portfolio is not meant to be an all-or-nothing proposition. Just as you might check your portfolio for diversification across assets and diversification across certain economic sectors, you may choose to diversify between long-term themes and near-term performers.

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Although many still ponder the possibility that the Dems and Repubs will fail to meet the Treasury’s 8/2 deadline, I found myself pondering a different question. Specifically, which sectors have had the most success since President Obama became actively engaged in the negotiations with members of Congress?

As described in the earlier article, Obama became intimately involved in the “bipartisan process” on 6/27. Here is how a variety of stock assets have fared through 7/20:

Noticing a number of clusters, I formed the “Gang of Six” sectors — each of which significantly out-hustled the broader market during the ”will-they-or-won’t-they” debating. In particular, gold mining success is likely tied to the record run for the underlying commodity during the heightened state of uncertainty.

That said, ”risk on” cyclical segments like energy, materials and Internet products/services revved up in the period. One might even be inclined to suggest that they’ve ignored double-dip housing concerns, debt woes across the developed world landscape, inflation throughout emerging countries as well as dreadful unemployment stateside.

One could give a nod to earnings. Indeed, corporations have handily trumped expectations. Equally plausible, however, is fund flow back into commodities. Whereas investors had yanked money throughout the second quarter, they’ve returned by the droves in July. The activity may have had a hand in boosting energy and materials exploration stocks.

And there’s yet another explanation. Stock market investors, much like bond market investors, have simply used the debt ceiling debate as an opportunity to buy the proverbial dips.

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Not sure about those annoying click-through links? The average price paid per click on Google’s network rose 12% over last year. Don’t believe that the Google Plus social networking plan can compete with Facebook? “G Plus” brought in 10 million newbies in its first 2 weeks!

Granted, the ultimate Internet information provider is still -6% below 2011 highs and roughly -23% off of the October 2007 peak. That said, those who declared Google a dinosaur may have been premature.

Here are 7 of the more popular tech ETFs with their applicable Google weightings:

Based on the higher performance figures for Internet-related ETFs, one might leap to the conclusion that Google exposure had been a big reason for the boost. In actuality, Google (GOOG) gained 30% year-over-year, whereas FDN and PNQI packed on 46% and 52% respectively. Even the Nasdaq 100 proxy, QQQ, has had a slight edge.

Google shares have been far more volatile than any of the above-mentioned ETFs over the past 5 years. Moreover, investors often prefer ETFs to diversify away from single stock risk. It follows that if Internet stocks scare you, you might not want to travel the sub-sector path; both FDN and PNQI have a great deal riding on Google (GOOG), Amazon (AMZN) as well as eBay (EBAY).

On the flip side, exactly one year ago to the day, I offered, “Three ETFs With Trend-Busting Street Credentials.” In the July 15, 2010 feature, I explained why First Trust Internet (FDN) was on my “buy list.”

Naturally, investing in an Internet ETF requires some belief in a 2.0 wave. Yet, more importantly, you need to manage your downside risk with stop-limit loss orders. Without an exit strategy, the most devout believer shrinks like a violet in a garden of roses.

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While I don’t disagree in principle, I do disagree in principal. (Note: Fundamental valuation fanatics need to look back at Forward P/Es circa October 2007!)

In practical application, I won’t expose a significant percentage of client dollars to stock assets in a downtrend. It doesn’t matter if forward earnings projections are “attractive” when stocks are collapsing in a dot-com blow-up or a financial meltdown.

Similarly, I may expose client principal to market cap sizes or economic sectors on momentum, technical data and macro-economics. I may do so… even if those market cap sizes or economic segments have “unattractive” valuations. For instance, I still maintain some exposure to U.S. Small Cap ETFs for a number of clients because: (1) relative strength percentile rankings are still better than large caps, (2) the overall economy has been improving, (3) positions have not hit stop-loss limit orders and (4) the price of the Russell 2000 is still above its 200-day moving average.

On the other hand, the Forward P/E for the Russell 2000 has been near 20x for the last 15 months. That’s pretty darn expensive. And it has consistently been in the 20x forward earnings range while large-cap benchmarks have remained in the 12x-14x next year’s earnings estimates.

The fact that large-caps offer better fundamental value does have sway — enough sway that I have allocated more to the large-cap space than the small-cap arena. Nevertheless, one ought to consider a wider range of info – technical data, history, contrarian indicators, macro-economic data — when identifying possibilities for his/her portfolio.

Recently, researchers at Bespoke posted year-over-year Q1 2011 earnings estimates for all economic sectors. I’ve listed the anticipated rate of earnings growth alongside YTD performance.

Do the less impressive gains from tech and materials imply that the earnings estimates in those sectors may be less reliable? Or is it likely that valuations aren’t the only factor in asset selection?

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Why am I concerned about stock assets in the immediate-term? Did the recent rate hike by China give me pause to reflect, or was it the unexpected decline in the latest consumer confidence reading? Has the extreme level of bullishness in the American Association of Individual Investors Sentiment Survey ruffled my shirt collar, or was it the steeper-than-expected drop in residential home prices? Is the fact that stocks are hitting higher highs on lower volume raising my eyebrows, or am I wary of crude oil closing near its highest price per barrel since October of 2008?

Nope… none of the above. (Maybe the AAII Sentiment Survey results are a bit disconcerting.) In fact, most of the above-mentioned items actually benefit market-based securities because they help asset prices climb the proverbial “Wall of Worry.”

Consider how powerful the “Wall of Worry” really is. In 2010, the world has battled fears regarding: (1) the collapse of the “euro-dollar,” (2) an inability of sovereign European nations to pay debts, (3) pervasive summertime, double-dip recession prognostications for the U.S. economy, (4) a perceived anti-business White House, (5) expiration of Bush tax cuts, (6) technical chart disasters like the Hindenburg, (7) market manipulation scandals like the “Flash Crash,” (8) Korea, Iran, and Afghanistan, (9) 10% unemployment, and (10) foreclosure fiasco a la rubber-stamping. In spite of it all, stocks and commodities (a.k.a. risk assets) witnessed super-strong, double-digit percentage gains this year.

Okay, so something got under my skin, didn’t it? Yes… but that something is a “someone.” Let’s use an alias to protect the innocent and call him, ”Baxter.”

Having lost money in the dot-com collapse in 2000, and holding a deep-rooted antipathy towards Republicans, Baxter was one of the most bearish clients to join me in 2001. I made money for Baxter in small-cap value in 2001 and avoided equities in 2002. My conservative choices meshed with his “things are terrible” mentality. When technical and fundamental trends pointed to investing heavily in stocks and commodities and emerging markets in 2003, Baxter nearly pulled the plug on my money management authority. Every excuse in the book was on the table… from Bush to Iraq to deficits to joblessness to recession.

I proceeded to double Baxter’s accounts over the next 5 years and I protected him from the bulk of the 2008 financial collapse. Even as I made more money for him in 2009 and 2010, Baxter held firm to the same bearishness that had guided his thinking since 2000. True, he credits me with “saving him from himself.” But he also feels that his “bearishness” over the last decade was well-founded, even though we made money in the “lost decade.”

A few days ago, Baxter wrote to ask me if it might make sense to buy some shares of Citrix and Salesforce.com. The ultimate bear… born during dot-com despair… is now comfortable with individual securities? P/Es of 40+?

I explained that we had been faring quite well with First Trust Internet (FDN) and Rydex S&P Equal Weight Technology (RYT). And while that seemed to quell some of this new-found stock ardor, Baxter cited all of the rosy S&P 500 forecasts for year-end 2011 by the Goldman Sachs’s of the world.

I still anticipate a strong finish for 2011. And I still like funds like Rydex S&P Equal Weight Technology (RYT)… as I expect corporations to continue upgrading their networks, hardware, software and systems. Yet the greed in Baxter’s voice is evidence enough for me to keep my stop-loss limit orders firmly in place.

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It’s not like certain sectors haven’t been pulling their weight. SPDR Select Energy (XLE) and SPDR Select Consumer Discretionary (XLY) have not only been pulling their share of the cargo, they have set new high marks.

Still, you have to look a bit deeper. Certain industries, or sub-segments, appear to be making a case for a Santa Claus rally; others appear to be holding the overall market back.

1. Semiconductors. Has anyone else noticed the absence of the summertime phrase,”double-dip recession.” While precious few believe that the U.S. economy is yet capable of standing on its own… and certainly not the Federal Reserve… semiconductor stocks do not lead when economies are contracting. In fact, most market-watchers look to semis as a way to gauge the start of vibrant expansion. Reality or anomaly, investors are snapping up Semiconductor ETFs.

2. Oil Services. Near the market’s lowest ebb in July, I explained what made Oil Services ETFs remarkably attractive. And while I still favored the lower volatility and consistent gains of energy pipeline MLPs, I specifically expressed why investors should give Oil Services ETFs a serious look at the close of the election. It’s hardly a surprise, then, to locate iShares DJ Oil Equipment & Services (IEZ) or SPDR Oil & Gas Equipment/Services (XES) near the very top of a 1000+ ETF leader-board.

3. Retail. The momentum that has favored consumer discretionary stocks has been justified thus far. Consumers ratcheted up their spending on “Black Friday” as well as on “Cyber Monday.” What’s more, consumer confidence has been increasing alongside improving job numbers. However, the enthusiasm may hit a few potholes, perhaps when beating earnings expectations in January 2011 could result in ”selling the news.” Nevertheless, there’s no denying that SPDR Retail (XRT) as well as First Trust Internet (FDN) represent some of most successful retailers in the world — from Priceline to Netflix to Amazon to EBay.

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Never-mind the horrific calls he made the following year:

1. In April 2009, near Dow 7950, Roubini predicted the markets would retest the March lows of Dow 6500. They never did.

2. In July 2009, near Dow 8100, he described the market’s run as nothing more than a bear rally. Yet the Dow rose 38% over the next 9 months.

3. In October 2009, near 9700, Roubini called for a bearish 10%-20% pullback. Not only was he 6 months early, but the market’s sell-off went from 11200 to 9700. The current cyclical low is essentially at the same spot where Roubini first made his bearish call… 6 months earlier. You can’t be much more “off” than that.

In truth, I am not giving Nouriel Roubini a bad time; rather, this is more of a condemnation on fortune telling and the mainstream media’s need for heroes. Nobody has any idea what will happen… that’s the greatest certainty of all.

I’m not suggesting that one should ever dismiss the ideas espoused by intellectuals. Yet you have to be open to the possibility that a thinker will be wrong. And not just in the arena of market-based investing.

I’ve watched Nouriel Roubini pile on top of every crisis since 2008. He did not anticipate the investment markets rebounding form the sovereign debt fears, so he softened his stance on sovereign debt. He did not anticipate markets recovering from the U.S. “soft patch” either. In fact, Roubini all but assured a double-dip recession.

Now, with each passing week, the prophet keeps shifting his stance. 2^nd half GDP will grind to a halt? Well, that’s not the same as a double-dip. And in his latest commentary, he’s placed the double-dip possibility at 40%. Mr. Gloom is less and less gloomy with each passing day.

When Mr. Roubini has been wise enough to get out of the prediction game, he has put forward some sensible medicine for the ailing economy. For instance, he is advocating for a “payroll tax break.” This would get more money into the hands of employees immediately and it will encourage employers to hire… as they’ll be paying less for those new employees. Since it’s not a prediction of impending doom, however, his call for smart stimulus isn’t likely to generate much in the way of front page headlines.

 Of course, if you read between the back page headlines for Roubini’s “payroll tax break,” you can see that he has hope for the U.S. economy after all. That’s why you should get your “Buy List” ready for cash that you may still have on the sidelines.

Here are 3 ETF areas that deserve attention when respective ETFs pull back 3%-5% percentage points from intra-day peaks:

1. Small Cap Emergers. In a recent column, I demonstrated how smaller economies have lower correlations with one another and/or with large economies. The same can be said about small-sized companies in those smaller economies.

Essentially, you will be able to enhance your portfolio gains AND lower your risk by including small cap emerging stock ETFs. The relative strength demonstrates a likelihood of continued percentage performance. Meanwhile, the lower correlation gives you better diversification. Consider WisdomTree Small Cap Emerging Markets (DGS) and Market Vectors Small Cap Brazil (BRF).

2. Telecom. The valuation of the industry as a whole is magnificent, but this isn’t a valuation based market. Okay, fair enough. Then take a look at relative strength and you’ll recognize telecom as the strongest in the 10 U.S. sectors.

Andit gets better. The yield is second only to the slower-moving utilities. What’s more, if you’re looking for a recession-resistant arena, know that telecom equipment and wireless services were among the very few to grow during the 2008-2009 downturn. Consider Vanguard Telecom (VOX) and iShares Global Telecom (IXP).

3. “Apple ETFs.” If the U.S. stock market rallies in Q4, you know that it won’t do it without it’s Nasdaq champ, Apple (AAPL). On 9/17/10, when Apple fell slightly, we still witnessed $645 million flow into buying on the weakness.

ETFs with heavy exposure to the big AAPL? The Internet Architecture Fund (IAH) as well as First Trust Nasdaq 100 Technology (QTEC).

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