There’s a lot of chatter right now about the US stock market being overvalued. The ‘Buffet indicator’, which compares stock market capitalization to GDP (stock market cap / GDP) is currently at sitting about 121% or 2 standard deviations above its average of 69.7%. Another indicator, the Schiller Cape PE, which looks at the price to earnings ratio relative to the last 10 years. Also shows things priced high. Currently the Cape ratio is at 27.13, 62.6% above its mean of 16.69.
If the US is overpriced, what can you invest in and get a deal? Due to home country bias it can be difficult for investors to see, but the short answer is ‘lots of things’. Using the cape ratio (Schiller Pe), we can find value all around the globe.
This chart from Star Capital shows where the bargains are by cape ratio. Interestingly, brazil is still near the bottom of the cheap list, even after their 65%+ gain in the last 6 months (as measured by the iShares Brazil ETF EWZ). On a more Macro scale, emerging markets have low Cape Ratio of 13.6, along with developed Europe at 14.7.
Star Capital offers lots of other metrics for value based equities and I recommend checking it out (their website).
Once you look outside of the US, you’ll see nearly the rest of the world is a value. If follow any news headlines, you’ll also think, the rest of the world is falling apart financially. Emerging market and developed Europe equites have gone no where in the last couple years, so why should you invest in them? That logical is why there are very few successful value investors. Investing in value requires you to dive headfirst into the blood bath and have faith in the long term growth of value investing. The last time the US was in possible value criteria, many investors though the US was at its financial end… and here we are today.
There is statistical evidence in value investing. Rob Arnnott of Research Affiliates put together an awesome presentation which shows the correlation between Cape ration (aka Schiller Pe) and subsequent 10 year returns. “Want a 75% correlation on forecasting total return, look at the Schiller PE” Arnott says. The correlation to returns and Schiller PE isn’t limited to the US. He has similar findings across other asset classes. I encourage watching this entire video, but the cape forecast starts at 18:00.
Arnott’s expected 10 year returns for asset classes based on this metric (and other) can be seen on the Research Affiliates website. The 2 cheap asset classes mentioned earlier, emerging markets, and developed Europe both have the highest expected returns among the asset class specified, above 6% real return (adjusted for inflation). Us equities are currently on the low site of the chart expected with about 1% expected real return.
Of course nothing lasts forever. The tides of that chart will change, so it is important to have a system if you are diving into value investing. Meb Fabers paper, Global Value: Building Trading Models With The 10-year Cape, outlines a great strategy for value investing.