Why Buy the World’s Cheapest Stocks?

by Nicholas Vardy
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"[The current level of the cyclically adjusted price-to-earnings (CAPE) ratio] would suggest reducing your holdings of [U.S.] stocks, especially for a long-term investor. We can't time the market accurately, but we know that when it's this high, over the long term, it usually doesn't do great.”

- Robert Shiller

Yale University professor Robert Shiller is a rock star among economists.

Two editions of his best-seller Irrational Exuberance (2000 and 2006) predicted both the dot-com bust and the housing bubble. (The 2016 edition expanded coverage to the bond market bubble - a topic I covered last week.)

His undergraduate courses on investing are among the most popular at Yale.

Shiller picked up the Nobel Prize in economics in 2013.

Shiller’s name also defines one of the most cited ways to value the stock market: the “Shiller P/E,” also known as the “CAPE ratio.”

Sadly, if the Shiller P/E proves to be as accurate as Shiller’s other predictions, it spells bad news for investors in the U.S. stock market.

The U.S. Stock Market’s State of Play

The U.S. stock market has enjoyed a stunning run over the past decade.

Among the 47 global stock markets I monitor daily, the U.S. market - as measured by Vanguard Total Stock Market ETF (NYSE: VTI) - ranks first.

It also ranks within the top 10 for the past three- and five-year periods.

The bad news is that the prospects for the decade ahead are much less promising.

The Shiller P/E explains why...

It measures the current price of a market divided by the average of 10 years of earnings, adjusted for inflation.

Think of it as a long-term price-to-earnings (P/E) ratio.

With a ratio of 33.5, the U.S. stock market is almost twice as expensive as its historical average.

Through a global lens, the U.S. fares equally as poorly.

Germany’s StarCapital private equity firm uses the Shiller P/E to track 43 global stock market valuations.

Today, the U.S. stock market is the third most overvalued on the planet.

Only the stock markets of Ireland and Denmark are more expensive.

According to StarCapital , the cheapest market in the world is Greece - its Shiller P/E is negative 7.5.

Russia - the country investors love to hate - is next, with a Shiller P/E of 6.4.

The Czech Republic, Turkey and Poland round out the top five.

How Would Shiller Invest?

Now, I have no insight into Robert Shiller’s personal portfolio.

But the Shiller P/E does offer valuable insights into his thinking.

Today, I expect he is reducing - or at least not increasing - his holdings in U.S. stocks.

And he is likely investing in the cheapest foreign markets, as measured by the Shiller P/E.

With countries like Russia, Turkey and Poland in the mix, buying stocks on these overseas markets may seem impossible.

Luckily, there’s an ETF that offers a solution...

Each year, Cambria Global Value ETF (NYSE: GVAL) applies a Shiller P/E to 45 foreign markets across the world.

It then targets and invests in the 12 (or so) most attractive countries.

Currently, the top six country holdings are Austria, Brazil, Russia, Greece, Portugal and Poland.

As it turns out, Austria, Portugal and Poland were also among the world’s top-performing stock markets in 2017.

The ETF has also almost doubled the returns of the market cap-weighted Vanguard FTSE All-World ex-US ETF (NYSE: VEU) over the past two years.

 

 

I’ll leave you with two takeaways...

First, don't dump U.S. stocks and hide in cash because the Shiller P/E stands at an eye-popping high (though this is very tempting).

Instead, be cautious, buy fewer U.S. stocks... and brace yourself for lower returns in the years to come.

Second, allocate some of your new investments to global stock markets through a strategy like that of Cambria Global Value ETF.

Yes, holding the world’s most hated and obscure stock markets may be uncomfortable.

But with Robert Shiller’s track record for identifying long-term trends, it’s not a strategy I’d bet against.

Good investing,

Nicholas

Thoughts on this article? Leave a comment below.

Stay Stateside... Take Stock in the World

It's a stereotype (perhaps not without cause) that most Americans aren't interested in what's going on outside of the U.S. - and especially not in the global stock markets. If your investment strategy is mostly "America first," you can still take advantage of global trends by investing in a U.S. company making inroads overseas.

Last month, Chief Investment Strategist Alexander Green evaluated Stryker Corp. (NYSE: SYK), one of the recommendations in his Oxford Trading Portfolio...

With 76.4 million baby boomers moving into their golden years - each day more than 10,000 of us turn 65 - the demand for knee and hip replacements will soar in the years ahead.

And no one - with the possible exception of all these newly ambulatory men and women - will benefit more than Stryker Corp. (NYSE: SYK).

Based in Kalamazoo, Michigan, Stryker is a global leader in surgical products, with sales in more than 100 countries.

The company has logged 37 consecutive years of growth. A 20-year chart of its annual sales looks like a side view of a flight of stairs.

Earnings and dividends have marched steadily higher as well.

The firm makes an enormous array of medical products - from bone substitutes to surgical cement to operating room technology - used by tens of thousands of surgeons. In fact, Stryker is the world leader in total hip replacement products.

In addition to solid organic growth, the company is expanding through acquisitions. It has completed more than 40 buyouts in the last five years.

Stryker is expanding rapidly in international markets. It already has strong sales in Europe, Japan, Australia and New Zealand. And now it's making significant headway in Canada and many of the world's emerging markets.

The numbers here are excellent. Annual sales top $12.4 billion. The company enjoys a 22% operating margin. And it has a solid balance sheet with $2.5 billion in cash on hand.

In the fourth quarter, adjusted earnings rose 10.1% on a 10.0% increase in sales. The results beat Wall Street's expectations.

And I estimate earnings will rise from $7.14 a share this year to nearly $8 next year.

Stryker has a bright future - and demographics favor its business.

And as a cutting-edge innovator, Stryker regularly develops new products. As a result, no single business line represents more than 15% of total revenue.

Moreover, its nearly 5,000 global patents form an effective moat around the business.

- Donna DiVenuto-Ball with Alexander Green

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