The Mexico ETF is Down, But Not Yet Cheap

If there is anything positive to say about emerging markets stocks, and finding such niceties is difficult these days, it is that these equities and ETFs are inexpensive on a valuation basis.

The iShares MSCI Emerging Markets Index Fund (NYSE:EEM) has a P/E ratio of about 18.1 and even steeper discounts can be found with ETFs tracking EEM's constituent countries.

For example, the iShares FTSE China 25 Index Fund (NYSE:FXI) has a P/E of 13.2. Russian stocks, as is usually the case, are also trading at significant discounts to the broader emerging markets universe.

One market that despite its recent declines is not trading at a discount is Mexico and that could portend more downside ahead for stocks in Latin America's second-largest economy. In the past three months, the iShares MSCI Mexico Capped Investable Market Index Fund (NYSE:EWW) is the second-best performer among the five major country-specific ETFs tracking Latin American nations.

That is saying nothing, however, because EWW is down 16.4 percent over that time, a performance that is by no means good and is merely less bad than the dismal runs of the comparable Brazil, Chile and Peru ETFs. Despite that tumble, EWW has a P/E of almost 22.3 and a price-to-book ratio of nearly four, according to iShares data.

A large part of the reason why EWW trades at valuations that are rich compared to other emerging markets ETFs is sector allocation. Consumer staples and telecom, both defensive sectors, combine for over 46 percent of EWW's weight. Valuations on U.S. staples are also rich, but the corresponding ETFs do not feature a three-year standard deviation of 21.2 percent like EWW does.

Over the past three months, EWW has been 230 basis points more volatile than the iShares MSCI Chile Investable Market Index Fund (NYSE:ECH) and nearly 700 basis points more volatile than the Global X FTSE Colombia 20 ETF (NYSE:GXG). GXG is the one Latin America ETF that has outpaced EWW over that time.

The potential problem looming for Mexican stocks and EWW is the recent declines have not done much in the way of making Mexico look cheap relative to other Latin American markets. Worse yet, earnings do not appear to be justifying the prices investors would pay today for EWW and its constituents.

"We would highlight that we do not feel that current valuations adequately reflect how weak Mexican earnings have been so far in 2013 (on a market cap-weighted basis, Mexican earnings fell 10% short of expectations in 1Q-2013), nor adequately reflect the likelihood of further downward revisions in earnings stemming from a weaker-than-expected economic outlook in Mexico (with expectations for GDP growth having been cut from ~4% to ~3%)," according to part of UBS note posted in Barron's.

For technical traders out there, EWW offers plenty of warnings on that front as well. The ETF labors 15.6 percent below its 200-day moving average and just 3.3 percent above its 52-week low. EWW's recent string of closes below $60 are the fund's first in a year.

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