As pointed out in the previous article , both Buffett’s ratio of total market cap over GDP and Shiller P/E indicates that the US stock market is overvalued and is positioned for negative long term returns. Investors should probably look at other markets for bargains, though the US market may still go higher amid investors’ optimism.
Which markets are cheaper?
GuruFocus Global Market Valuation page extends Buffett’s indicator to other countries. The idea is that over time, the ratio of a country’s total market cap over its GDP will revert to the historical mean. If it is higher than the mean, the valuation is higher than its historical valuation and it may gradually go lower. If it is lower than the mean, the market is lower than its historical valuation and it has the potential to go higher. The process takes a full market cycle of 7-10 years.
With this in mind, we took at a look at the ratio of the total market cap over GDP for the countries that we can find data, as show below:
Please note that the historical range of the ratios of Total Market Cap over GDP are represented with stacked blue bars and green bars. The top of the green bars represents the maximum values that the ratios reached in the past, and the bottom of the blue bars are the minimum values. The border between the green bar and the blue bar is where the ratios currently stand. Therefore, the countries with above mean ratios are US, Germany, UK, Mexico, Switzerland, Sweden, and Belgium. Countries with far below historical average ratios are China, Japan, France, Brazil, India, Russia, Spain, Australia, and Singapore.
We will discuss a few countries that seem to be undervalued below:
Chinese stock market index SSE Composite is now about a third of where it was in Oct. 2007. But its GDP is more than doubled since then. Therefore the ratio of Chinese total market cap is less than 1/6 of where it was in Oct. 2007, and it is sitting at the lowest point since 1991.
If Chinese economy keeps its past pace of growth of 15.75%, and the ratio reverted to the historical mean of 165%, Chinese market can deliver a gain of more than 30% a year.
But now Chinese economy is the second largest in the world, and its growth has dramatically slowed down. If we assume Chinese economy grows only 6% a year in the next decade, and the ratio of total market cap over GDP doubles from where it is now, we should expect more than 17% a year from Chinese market from today’s level.
Like Chinese stock market, Brazil stock has been in down market for the last 3 years. Its current market valuation is the lowest in the last 8 years, and it is only about 25% higher than the lowest point in the last 16 years. See the ratio of total market cap over GDP for Brazil below:
Our model of reverse to the mean suggest that Brazil market may gain 18.8% a year from its current level. But that can be too optimistic because Brazil may not be able to grow 10% a year in the future. If we assume an economic growth of 5% a year, and reverse to the mean contribution of 3% a year, and the dividend yield of more than 3%, Brazil is still positioned at more than 10% a year from its current level.
The stock market of Singapore certainly did better than Chinese and Brazilian markets over the past several years. But the market gain does not fully reflect its economic growth. As a result, the ratio of its total market cap over GDP is close to the low end of its historical value over the past 15 years. See below:
The potential market return from economic growth, the reversion to the mean of the Buffett ratio, and the dividend may give returns of more than 17% a year.
Dividends and Reversion to the Mean
Though we are optimistic about the countries we discussed above, many of them do not have enough history to make the conclusion more convincing. An alternative way of looking for value is to invest in countries that have high dividend yields, and have potential of return from valuation reversion to the mean.
This is the dividend yields of the indices from the countries we cover.
This is the potential return contribution from reversion to the mean:
Clearly, countries like Singapore, Australia, Spain, China and Brazil have the highest dividend yields. Countries like China, Russia, Singapore, Italy, Brazil have the highest potential from reversion to the mean. If we combine both, the best places to invest now seem to be China, Singapore, Spain, Italy, Brazil etc.
Please note that this kind of market prediction is never for near term. Both Chinese market and Singapore showed large potential a year ago, but US market did the best in 2013. Now US market is clearly indicating long term negative returns. Investors should seriously look at global markets for bargains.
A good place to start will be GuruFocus Value Screens. For instance, Undervalued Predictable Companies for China here and Europe here. Or our favorite Buffett-Munger Screener for Chinese market here. Or simply look at what the best Global Market Gurus are buying.
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