Something that looks cheap sometimes turns out to be just a value trap into which unwary investors may tumble, so when looking for pockets of value (or growth), it’s important to look at data in the proper context.
Second only to “where’s the growth?”, the question dominating investors’ minds these days has to be “where’s the value?” And by value, they mean not just markets that happen to be cheap for very good reasons, but where stocks appear inexpensive relative to their fundamentals and relative to their long-term growth prospects.
With the help of Datastream, AlphaNow has generated some ideas. Only a handful of major markets – four of those we surveyed, to be precise – carry a valuation today that is higher than their 10-year average. That means that there are a number of markets in virtually every corner of the world that look very cheap, in either absolute or relative terms. But it is only by setting these markets in context that it’s possible to get a sense of where the greatest opportunities may be found.
ABSOLUTE VALUATIONS
In the chart above, you can see clearly the ranking by absolute valuations, with Mexico one of the world’s priciest markets today, trading at 16 times the forward price/earnings ratio of the MSCI Mexico Index. At the other end of the spectrum lies Russia’s RTX index, now commanding a forward price/earnings ratio of only 4.4.
Not surprisingly, perhaps, Europe’s major market indices are toward the bottom of this list, with some emerging markets and markets of nations that are commodity producers – Canada and Australia, among them – being closer to the top. Re-ordering the list, as in the chart below, can produce some even more intriguing results, however. Mexico’s P/E of 16 is not only the highest in absolute terms, but represents the biggest premium to the country’s average valuation over the last decade; the figure of 125 signifies that it currently trades at 125% of that 10-year average price/earnings ratio. In contrast, Russian stocks seem remarkably inexpensive, with its forward P/E ratio is the lowest of the group, at 4.4, and its relative P/E, trading at only 57% of its 10-year average valuation. Some of that may be explained by the fact that the Russian market is dominated by sectors that traditionally carry lower P/E ratios, such as energy companies and financial services concerns, but it may also signal that there are some bargains to be found in Russia right now for investors able to conduct the right amount of due diligence and research.
The two charts, above and below, serve as “heat maps”, with red signaling markets that investors might see as overvalued. Again, comparing the two rankings throws up some food for thought. In absolute terms, South African stocks today appear cheaper than those in the United States or Canada. But when compared to the country’s average growth, valuation concerns become more apparent: South Africa trades at 106% times its 10-year average, Canada at 85% and the United States at 84%.
RELATIVE VALUATIONS
Of course, what matters most to any investor is what is going to happen next, not what has already taken place in the past. It’s great to know that Russian, Japanese, German and Chinese stocks all look cheap relative to their history, and that of those, Russian and German stocks also are very inexpensive in absolute terms. But what happens in the future will be shaped by economic growth, so it makes sense to move on next to put those valuations in the context of growth forecasts for those countries.
GDP GROWTH FORECASTS
Open refreshable Excel template (needs Datastream DFO addin)
In this case, while Germany may be flashing “green” on the valuation indicators, when it comes to growth, the warning signs are clearly in evidence. According to forecasts from Oxford Economics via Datastream, the country’s GDP is expected to grow a mere 0.7% this year – a full percentage point below the average annual GDP growth rate it recorded between 2000 and 2007, before the financial crisis hit. In contrast, GDP growth in China and Russia may have declined by more in absolute terms – about 3 percentage points for both nations – but Oxford Economics still predicts that in absolute terms, growth will be high, with Chinese GDP expanding 7.5% this year and the Russian economy growing 4.2%. (Of course, should China’s growth slide still further, to 6% or so, say, regardless of how attractive it may still appear on an absolute basis, investors might well want to brace themselves for market trouble.) Japan also appears likely to grow at above its average GDP growth rate of 1.5%, with Oxford Economics calling for 2012 GDP to climb by 1.9%.
Developing a global asset allocation model in the current environment is tricky, to say the least. The extent to which Europe’s sovereign debt crisis will spread beyond its borders and put an even larger dent in growth in the emerging markets or North America remains unclear, as does the degree to which some of those countries will be able to replace European demand for their goods. As these tables reveal, it is only by look at the economic context in both absolute and relative terms that it’s possible to begin the process of deciding what corners of the world to overweight or underweight.
