Why S&P 500 ETF Is Still Cheap Despite 13% Gain


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Major ETFs weakened slightly Monday, following the lead in European markets.

In afternoon trade, the SPDR S&P 500 ( SPY ) gave back 0.06%.

SPDR Dow Jones Industrial Average ( DIA ) andPowerShares QQQ ( QQQ ), a basket of the 100 largest nonfinancial stocks on the Nasdaq, were flat.

The S&P 500 is up 12.8% year to date. It's trading only 9.4% below its record high of 1565 on Oct. 9, 2007. At its record high, the forward earnings of the S&P 500 stood at $103.62, and the forward price-earnings ratio was 15.1, according to Ed Yardeni, president and chief investment strategist at Yardeni Research. Today, the forward earnings are at $110.81, while the forward P-E is 12.7. That means the market is currently 15% cheaper than at its record high, with earnings 7% higher than back then.

"The three corrections over the past three years were all triggered by worries about the Euro mess, concerns about stalling U.S. economic growth, and fears of a hard landing in China," Yardeni wrote in his daily client note. "The subsequent relief rallies occurred because 'endgame' scenarios were averted or at least postponed by policy responses and better-than-expected economic indicators. In addition, corporate earnings proved remarkably resilient during the sinking spells in stock prices, which contributed to their rebounds."

And the same fears prevail now. Furthermore, the Fed and central banks around the world have made borrowing rates very low to push investors to buy stocks and bonds, Yardeni added.

"Equities are building more and more strength, but with quiet, unassuming conviction," Waverly Advisors wrote. "We believe that many analysts are probably missing the message of the market, and this sets the stage for a dramatic rally when sentiment does shift." The firm is long S&P 500 futures, while shorting 30-year Treasuries.

The bears, on the other hand, see the summer rally as a chance to book profits and take risk off the table on the expectation of lackluster corporate profits in the near future. With nearly all of the S&P 500 companies having reported earnings, the S&P's second-quarter earnings grew 8.4% year over year, primarily because of easy comparisons in financial stocks, according to Thomson Reuters. If financials are excluded, second-quarter earnings growth is merely 1.4%. Analysts expect a 0.3% decline in third quarter.

"With earnings growth having stalled, combined with signs of a worldwide economic slowdown, our view toward stocks has become more cautious, particularly given the summer rally we have seen," Regina Shafer, a vice president of fixed income investments at San Antonio, Texas-based USAA Investment with $50 billion in mutual fund assets, wrote in a commentary.

She's underweighted her portfolio in stocks, while overweighting high-yield and investment-grade bonds and precious metals stocks.

IShares MSCI EAFE Index ( EFA ), tracking developed foreign markets, shed 0.08%.

IShares MSCI Emerging Markets Index ( EEM ) let up 0.10%.

Follow Trang Ho on Twitter @TrangHoETFs .

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

This article appears in: Investing ETFs
Referenced Stocks: DIA , EEM , EFA , QQQ , SPY

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