Global Market Valuations and Expected Returns – May 6, 2014

In January 2014, the stock market benchmark S&P 500 lost 3.36% after the excellent 2013. The enthusiasm went back as the market gained 4.31% over February. In March, it went up only 0.69%. And in April, it was about even for the whole month. What is the situation in the other parts of the world? In April, the key indexes in Europe had positive return figures. Germany’s DAX index increased 0.50%. France’s CAC-40 index gained 2.18%. The FTSE 100 index went up 2.75%. Stock markets' performances in Asia were weak. Japan’s NIKKEI 225 decreased by 3.53%. Hong Kong’s Hang Seng Index was moderately down by 0.08% and China’s SSE Composite index was down by 0.34%.

In Tweedy Browne Global Value’s 1st Quarter Commentary, they said, “After a strong year-end finish, global equity markets plateaued in the first quarter of 2014 as slowing growth in emerging markets and increasing tension in a number of regions slowed the building equity market momentum of 2013. As we have said before in some of our more recent updates, we are now five plus years into a strong recovery in equity prices, which in our opinion has outstripped the underlying economic recovery. It should come as no surprise that most securities are, in our view, fairly and, in some instances, overpriced. While we are seeing some new idea flow in lesser developed economies, it is not enough to offset the pruning we have been doing in our Fund portfolios and, as a result, we hold more cash reserves than we would like. Many so called “new technology and media” companies today trade at what we feel are nosebleed valuations, and as we write we are seeing a bit of a correction in those shares. Should that activity, or any of the macro fires that are burning around the world, begin to affect the broader market, we may very well get an opportunity to put some of the Funds’ cash reserves to work. In the interim, we will remain patient.”

In Matthews China Fund’s March 31, 2014 Commentary, they said, “During the first quarter, China’s equity markets reacted negatively to signs of an economic slowdown. In particular, investors appeared most concerned about China’s industrial production, export data and retail sales figures that suggested a further downturn in the economy could be taking place. In addition, a corporate bond default from a Chinese solar company added new concerns regarding the health of China’s financial sector. Under these circumstances, the first quarter experienced substantial selling pressure across most major sectors in the country’s equity markets. With near-term economic indicators turning more bearish, it is becoming increasingly likely that China will roll out more accommodative monetary policies and supportive fiscal measures in order to boost its economy. However, we do not expect a stimulus plan as significant as the one the government rolled out in 2009. It appears that China is prepared to undergo short-term pain to achieve its longer-term goal of rebalancing its economy for a more sustainable growth path. Over the longer term, we feel that the consumer sector and service industries will develop well as domestic consumption becomes increasingly important amid China’s more market-oriented economic landscape.”

In Matthews Japan Fund’s March 31, 2014 Commentary, they said, “Japan’s equity market corrected during the quarter as the country readied itself for its April 1 sales tax hike. There was some undue speculation late last year that the Bank of Japan would preemptively expand its quantitative easing policy before the tax hike. Those policies did not materialize, prompting the unwinding of long positions in Japan by short-term investors. Net selling by overseas investors totaled more than US$18 billion during the quarter, the first quarterly outflow since mid-2012. There appear to be strongly conflicting viewpoints in terms of Japan’s growth outlook. Headline GDP numbers for the fourth quarter of 2013 were poor. GDP growth of a mere annualized 0.7% fell woefully short of market expectations, and was particularly disappointing for top-down investors. On the other hand, the latest set of quarterly earnings was strong, with many companies revising up their earnings guidance. In that sense, the bottom-up perspective is encouraging. This divergence in the numbers has shaken confidence somewhat ahead the oft-discussed consumption tax hike. Despite the uncertainties, we believe the valuations of Japanese equities are now quite attractive and there are strong buying opportunities for bottom-up fundamental stock pickers—especially relative to other developed markets. Given this environment, we intend to stay close to our core competence of picking stocks based on bottom-up fundamental research.”

In Matthews Pacific Tiger Fund’s March 31, 2014 Commentary, they said, “Asia’s capital markets endured a rocky start to the year as investors continue to wrestle with an environment of slowing growth in China. This has been partly offset by a tempering of concerns over the impact of the U.S. Federal Reserve’s tapering policies on economies like India and Indonesia. Recent economic indicators coming out of China seem to suggest that the economy has lost some steam. As a result, Chinese equities continued to detract from absolute returns for the strategy. Looking ahead, concerns over an impending collapse in China seem to be overdone. Similarly, expectations of a sharp recovery in regional economic growth also seem misplaced as it may take longer for policy-led initiatives to translate into underlying economics. Meanwhile, valuations across a variety of sectors are at or below long-term averages; although there is wide dispersion between sectors. For example, Internet-related businesses continue to trade at levels that leave little room for disappointment, prompting us to trim some of the holdings. By contrast, we continue to like the long-term prospects for sectors like consumer discretionary where a cyclical slowdown is leading to more acceptable valuation levels.”

In T. Rowe Price Japan Fund’s Quarterly Commentary, they said, “Japanese equities declined over the quarter. Along with the geopolitical concerns facing most global markets, anxieties about an economic slowdown in China also resurfaced and prompted investors to repatriate money into safe-haven assets, including the yen. This currency strength hit the stocks of Japanese exporters, in particular. Japan's looming consumption tax hike also played a role in dampening the domestic stock market. On the upside, however, retail sales rose unexpectedly as consumers increased spending ahead of a hike in the consumption tax. We believe domestic consumption driven by wage inflation needs to be the next growth engine for a sustained recovery in Japan. Prime Minister Shinzo Abe has been applying intense pressure on corporations to raise wages in order to support the Japanese consumer and reverse a 20-year cycle of wage and price deflation. Labor market tightening, healthier corporate profits, and corporate tax incentives should eventually boost wages. While bonuses are starting to increase, however, we have yet to see firm evidence of a rise in base wage rates, making 2014 a critical year for evidence of a positive wage cycle to emerge.”

In Value Partners’Â 2013 Annual Report, it stated, “We remain optimistic about the longer-term future for China following the Third Plenum as it laid the foundation for China’s success in the next decade. Much like a slow burn, while the flames of changes have been lit, the embers have yet to heat up to their true potential. While we are positive about the outlook for markets in 2014, we do recognize that a re-rating may not happen immediately. In addition, we still see some risks, most notably overcapacity in certain sectors, shadow banking and debt uncertainty, as well as further concerns on the property market in China. We continue to remain fully invested and are committed to our value investing discipline and strong research-driven idea generation. We believe an overly bearish consensus view on Chinese equities is still putting pressure on the Chinese markets, which are trading at depressed price-to-book and price-to-earnings valuations. As a result, we are very enthusiastic about the potential investment opportunities in China in 2014. As a long-term investor in China, Value Partners (Trades, Portfolio) is well positioned to navigate through these volatile times. We look forward to the journey ahead.”

In IVA Funds Annual Report, Charles de Vaulx and Chuck de Lardemelle mentioned, “Even though we argued over the past year that equities would probably be the best house in a bad neighborhood, we have not been fully invested in equities and, in fact, we have reduced our allocation to equities and simultaneously raised our cash levels as the year progressed.

Europe remains difficult for us. The eurozone economics are witnessing some degree of stability but many weaknesses remain (worsening public debt, costly credit, vulnerable banks...).

We have had almost no direct investments in the BRIC countries (Brazil, Russia, India and China) in recent time. However, we made our first investment in Brazil over the period; we also added a few names listed in Hong Kong doing business exclusively in China. But these markets are not cheap enough for us to make large commitments. In China, in particular, we worry about massive misallocation of capital and a potentially moribund banking sector.”

We reviewed the U.S. market valuations and the expected return and found that the U.S. market is expected to return 1.1% to 2.4% a year in the upcoming years. The global market provides a totally different picture. The returns in some countries predict much higher.

The details of how to estimate the future market returns of the global market, the data sources, and the interpretation of data have all been discussed in great detail in our new page of Global Market Valuations. Please go to that page if you want to learn more and have unanswered questions.

Please note that there are large errors in predicting the future returns of emerging markets because not enough historical data is available. These countries may not be able to grow at the same rate as they did before. But in general, the chance of having better future returns is higher for these markets that are traded below historical means than for those that are traded above.

As of May 6, 2014, the expected returns for the global market are shown in the chart below:

Among developed countries, Singapore has the highest expected market returns, which is 17.1%. Australia sits in the second place. Spain ranks in the third place with an annualized return of 10.7%. The expected returns are in the order of mid-teens a year. Among developing countries, the Chinese market is still the highest. The expected return is in the order of 36.5% a year.

These are the details of the expected returns for the world’s largest markets:

Three factors decide the expected returns of the market. They are: economic growth, dividend payment and current market valuations. If the current market valuation is below its historical mean, the contribution from the reversion of the market valuation to the mean is positive. Otherwise, it is negative.

Among developed countries, contributions from reversion to the mean for Sweden, Canada, UK, Switzerland, U.S., and Germany markets are negative because the stock markets in these countries are traded above historical means. For developing countries, Indonesia and Mexico are negative. The details can be seen in the chart below:

For detailed information and data interpretation, go to the page of Global Market Valuations.

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