Recently, I had the pleasure of reading Meb Faber’s excellent e-book ‘Global Value: How to spot Bubbles, Avoid Market Crashes, and Earn Big Returns in the Stock market’. The book discusses the importance of value based investing in stock markets globally and for me it highlights the importance of price when purchasing shares in a business and the dangers of simply operating a strategy of buying stocks no matter the prevailing market price.
Meb Faber has utilized Robert Shiller’s development of the Cyclically Adjusted Price Earnings Ratio (CAPE) to apply it to global stock markets and the findings are illuminating. For those not familiar with Robert Shiller’s work, he expanded on the pioneering work of Benjamin Graham and David Dodd in their 1934 book ‘Security Analysis’, to create his CAPE formula and method of stock valuation, which uses the past 10 years average earnings to assess whether stocks are valued attractively or whether they are overpriced, rather than 1 year in the simpler and more commonly known P/E ratio.
The table below illustrates just how far investor sentiment and economic conditions can influence how many multiples of earnings investors are willing to pay for a business.
The divergence between min/max CAPE ratios are large and illustrate the extreme levels of pessimism and optimism that frequently exist in financial markets.
So what are the investment implications of purchasing cheap stocks as indicated by the CAPE ratio?
Well Meb Faber and his team at Cambria Investment Management researched historical stock market performance for 32 countries and the possible implications for your investment choices.
“We then set out to test CAPE in a similar manner. Starting in 1980 we sort all countries by CAPE, and invest in the most undervalued x%, rebalanced yearly. We also show the effects of investing in the most overvalued x% as well as a long/short portfolio. These returns are real returns net of inflation, and with yearly data (which will naturally understate drawdown figures). The sample includes approximately 10 countries in 1980, 20 in 1990, and 30 by 2000.” Meb Faber.
As the majority of financial professionals and private investors today do not tend to take concentrated stock positions, I will illustrate the portfolio that you could buy at the present time utilising this method of the top 33% cheapest stocks based on CAPE, or the cheapest 10 markets. (I have only utilised the 32 countries outlined within Meb Faber’s book).
The data for these 32 countries and many others can be found at www.starcapital.de/research/stockmarketvaluation.
|Greece||Global X FTSE Greece 20 ETF (USD)|
|Russia||This market has the most investment choices available with the option of the Neptune Russia and Greater Russia Funds or the JPM Russian Securities plc Investment Trust, in the traditional funds space or through the iShares MSCI Russia ADR/GDR UCITS ETF (GBP).|
|Portugal||Global X FTSE Portugal 20 ETF (USD)|
|Austria||iShares MSCI Austria Index fund (GBP)|
|Brazil||HSBC MSCI Brazil UCITS ETF (GBP)|
|Italy||iShares FTSE MIB UCITS ETF (GBP)|
|Ireland||iShares MSCI Ireland Capped ETF (USD)|
|Spain||Amundi ETF MSCI Spain UCITS ETF (GBP)|
|Turkey||iShares MSCI Turkey UCITS ETF (GBP)|
|South Korea||iShares MSCI Korea UCITS ETF (GBP)|
Sources: www.morningstar.co.uk, www.trustnet.com, www.globalxfunds.com, www.ishares.com/uk
Fortune Favours the Brave
It is clear that some of these markets are experiencing significant problems and many people would view you as foolish to invest in them. That is however part of the appeal. These perceptions cause the demand for these stocks to be low and therefore the prices are cheap, especially relative to many other stockmarkets.
The research put forward by Meb Faber in his book is compelling and I feel should warrant attention from all investors.
For the brave few, there could be some very attractive 10-year returns available.