Scott Martindale, senior managing director for Sabrient Systems, compares ETFs tracking different geographical regions
With the tremendous growth in ETFs and electronic trading platforms for access to global exchanges, the self-directed investor has more choices than ever. But how to evaluate the vast array of choices?
In general, one begins with a broad asset allocation decision among asset classes like equities, fixed income, commodities, and real estate. Within each asset class more specific investment decisions must be made, and the preponderance of choices among ETFs has made it easier to invest in baskets of stocks such that stock-specific, or unsystematic risk can be minimized.
In the equity portion of a portfolio, investors may choose a rotation strategy among global geographical regions and then perhaps drill down further to specific countries within the selected region. Investors can perhaps go further to select specific industrial sectors within a given country and then even individual stocks within those sectors.
Comparing geographic regions
Let’s focus on identifying the most desirable geographical regions. There are fundamental analysts who will perform top-down analysis considering factors like currencies, demographics, regulatory environment, education, technological trends and innovation. On the other hand, a technical analyst will rely upon historical trends of price, volume, and accumulation/distribution in an attempt to extrapolate future direction.
US-based quantitative research firm Sabrient Systems employs a proprietary “SectorCast-ETF” ranking model that seeks to quantify both technicals/investor sentiment as well as fundamentals/analyst sentiment. The model creates a bottom-up composite profile of a given basket of stocks, such as an ETF, for relative rankings.
As each ETF is unique with its own set of underlying stocks and relative weightings, different ETFs that seek to represent Europe or Asia or the US will score somewhat differently. For this article, I am comparing five ETFs that trade on US exchanges. Three comprise prominent firms in Europe, Asia, and Emerging Markets through American Depository Receipts (ADRs). I am comparing them against two ETFs that represent US large caps and US small caps.
These ETFs comprise the BLDRS Europe 100 ADR index (ADRU), the BLDRS Asia 50 ADR index (ADRE), the BLDRS Emerging Markets ADR index (ADRA), the SPDR S&P 500 ETF Trust (SPY) and the iShares Trust Russell 2000 (IWM).
Normally it is like apples and oranges when trying to compare stocks from different countries that trade on different exchanges, due to differences in accounting standards, reporting practices and exchange listing requirements. However, because so many international stocks fulfil US listing requirements in order to trade as ADRs, that chasm has been bridged and meaningful comparisons can be made.
The Outlook rank employs a fundamentals-based multi-factor algorithm that includes current and projected valuation, earnings growth consensus forecasts, trends in Wall Street analyst revisions to their earnings estimates and various return ratios. The Bull and Bear ranks quantify investor sentiment by measuring how the ETF’s underlying equities have tended to perform over the previous two months on particularly strong or weak market days, respectively. Each is scored on a scale of zero to 100, with higher scores better. As you can see, none of the ETFs score at the extremes since each is broadly diversified across sectors.
Also, broad market-cap weighted indices favour growth over value, which tends to lead to lower Bear scores. Not surprisingly, the highest Bull scores among this group come from the US small caps and Emerging Markets, since these tend to comprise more speculative issues.
Given that prominent market pundits are predicting everything from the “crash of 2010 coming” to “major surge ahead” for the US and global stock markets, it is helpful to an investor to understand what each of these scores say about how a given ETF might be expected to perform in either a further technical breakout or a nasty sell-off.
Not surprisingly after such strong recent performance among small caps, IWM is showing the worst forward-looking value among the group but also the highest Bull score, which is typical of what many observers are calling a “junk rally” in which the more speculative issues lead.
You might be curious to know how ETF scores and performance have tracked lately. The lower part of the table shows Europe and Asia have underperformed between mid-March and mid-April. As global markets have been bullish, not surprisingly this has translated into significantly lower bull scores for ADRU and ADRA. However, Europe’s Outlook score has increased as relative valuations have improved while analysts have been upgrading estimates. On the other hand, Asia’s Outlook score has decreased due to more analysts reducing estimates.
So what exactly are the latest scores suggesting to global investors for the next few months? Well, from a fundamental valuation standpoint, Europe is looking quite good relative to Asia, Emerging Markets and US large and small caps. The table is also saying that if you fear the potential for a significant market pullback but wish to stay invested, the SPY is a safer bet. But if you would like to be best positioned for further upside in the international equity markets, Europe has been lagging and is showing the most compelling values.
Scott is senior managing director for Sabrient Systems, an independent quantitative equity research firm based in the US. Scott has worked in management consulting and a variety of managerial, analytical, and engineering positions with Chevron.
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