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Vera Yuan
Vera Yuan
Articles (1063) 

Global Market Valuations and Expected Returns – April 4, 2014

April 04, 2014 | About:

In January 2014, the U.S. stock market benchmark S&P 500 lost 3.36% after an excellent 2013. The enthusiasm went back as the market gained 4.31% over February. In March, it went up only 0.69%. The market benchmark S&P 500 closed at 1890.90 on April 2, 2014, which is the new record high. What is the situation in the other parts of the world? In March, the key indexes in Europe returned negative. Germany’s DAX index declined 1.40%. France’s CAC-40 index lost 0.38%. The FTSE 100 index was down 3.10%. Stock market performances in Asia were weak too. Japan’s NIKKEI 225 moderately decreased 0.09%. Hong Kong’s Hang Seng Index was down 3.00% and China’s SSE Composite index was down 1.12% due to the weaker-than-expected Chinese economic data.

Seth Klarman has returned $4 billion to clients at 2013 year-end due to lack of ideas and has 40% of the portfolio in cash. In his 2013 letter to investors, he mentioned the Continuing Problems in Europe, “Europe isn’t fixed either, but you wouldn’t be able to tell that from investor sentiment. One sell-side analyst recently declared that ‘the recovery is here,’ a sharp reversal from his view in July 2012 that Greece had a 90% chance of leaving the Euro by the end of 2013. Greek government bond prices have nearly quintupled in price from the mid-2012 lows. Yet, despite six years of painful structural adjustments, Greece’s government debt-to-GDP ratio currently stands at 157%, up from 105% in 2008. Germany’s own government debt-to-GDP ratio stands at 81%, up from 65% in 2008. That doesn’t look fixed to us. The EU credit rating was recently reduced by S&P. European unemployment remains stubbornly above 12%. Not fixed.

Various other risks lurk on the periphery: bank deposits remain frozen in Cyprus, Catalonia seems to be forging ahead with an independence referendum in 2014, and social unrest continues to escalate in Ukraine and Turkey. And all this in a region that remains saddled with deep structural imbalances. As Angela Merkel recently noted, Europe has 7% of the world’s population, 25% of its output, and 50% of its social spending. Again, not fixed.”

In Chou RRSP Fund (Trades, Portfolio) 2013 Annual Report, Francis Chou, the fund manager in Canada said, “We believe that the market is currently fairly valued and we sincerely doubt the overall returns from equities in general over the next five to 10 years will be compelling. On the contrary, we believe the returns may be far more modest than those hoped for by investors. Not only are the P/E ratios and price-to-book values still high and dividend yields low relative to historic valuations, but the number of companies that are underpriced is at an all-time low. In light of this scenario, and with its obvious lack of bargains, we would not hesitate to sell our investments and be 100% or 50% cash - or whatever the number may be.

In Hennessy Japan Fund’s Portfolio Manager Commentary, the portfolio manager Masakazu Takeda said, “Even though the Japanese market was up over 50% in yen terms in 2013, equity valuations are not expensive by historical standards. The current price-to-earnings ratio is approximately 16Xs and not expensive relative to other Asian markets. In addition, today’s equity valuations are substantially below the huge premiums (30-40Xs price-to-earnings ratio) that investors paid for Japanese equities in the 1980s and 1990s. Given the secular changes that are taking place within the Japanese economy and the expected continued devaluation of the yen, we believe that there is considerable continued upside potential in Japanese equities.”

In Invesco European Growth Fund’s Quarterly Performance Update, it said, “Looking ahead to 2014, global economic and stock market performance are likely to be influenced significantly, first by how confident investors are that the US economy can withstand the Fed’s “tapering” process (and consequent higher interest rates) without stalling, and second, by the ability of Eurozone economies to finally raise their growth rates from stagnant to a more meaningful recovery while avoiding a recurrence of fiscal/bank solvency problems. Overall, investors will be seeking confirmation that the early signs of economic improvements can be sustained, thus helping to support the strong equity market gains to-date. Within Europe, valuation levels still appear favorable relative to other regions and generally low expectations may increase the potential for positive surprises. The UK has showed steady signs of economic acceleration, but the Eurozone still seems to offer relatively modest growth prospects. That said, some peripheral economies (e.g. Spain) are improving as fiscal austerity eases.”

In Value PartnersFourth Quarter in 2013 Commentary, it wrote, “Consequently, we believe this presents a profound opportunity for investors. 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. However, we believe the Chinese government is well aware of these and taking appropriate steps to help allay these threats. As a result, 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.

On Nov. 4, 2013, Chairman of Oaktree Capital Group LLC, Howard Marks, said in Shanghai that China’s equities aretremendous bargains” while U.S. stocks are “fairly to fully valued.” He believed just as investors were too optimistic to China’s market three years ago, now they were too pessimistic. Right now the Shanghai Composite's price-to-book ratio is about half of 2010's level and the P/E multiple is 42% lower. “We are investing in Chinese equities along with emerging markets,” Marks said. “Investors have lost all confidence in China.”

In GMO International Active Update Fourth Quarter letter, it said, “In fact, we believe there are particularly cheap stocks in Europe, Japan, and Emerging Asia. In Europe, value still resides in companies geared to a domestic recovery. We believe industrials, materials, and financials that have significant business exposure to the European economy represent a compelling opportunity. Many of these companies are in the midst of restructuring, cutting costs, and reducing leverage. Companies that are able to achieve breakeven or even positive cash flow on currently depressed revenue levels should reward investors if the European recovery becomes more robust.

Japan continues to pursue structural reform under Abe’s Three Arrows program. The most important policy remains the first arrow of monetary stimulus intended to create nominal asset price increases. Margins in Japan are still very low and operating leverage is so high that, even with modest restructuring and a modicum of pricing power, corporate profits could improve dramatically. With current earnings, valuation looks fair but if policy measures achieve their goals the market is compellingly cheap. The equity market will continue to favor those companies that should benefit from a modestly devaluing yen such as banks, retailers, and industrials. In the midst of these broader themes there can still be found a cohort of Japanese companies that continue their march toward greater efficiency and higher profitability, and that will reward investors regardless of what happens in the broader economy.

In emerging markets, there is the appearance of extreme value, but those stocks that are optically cheap come with high risk. There are only a few countries in aggregate selling below 10 times earnings and all of them are in the emerging markets: China, Russia, Turkey, and Korea. We are most excited about Korea and Turkey. Korea has been out of favor with investors for several years and, as a result, a number of franchises with strong competitive positions can be bought on the cheap. Turkey has some isolated opportunities but it is a struggle to find enough liquidity to make these ideas impactful. In Russia, value is found primarily in the resource sector and comes with an uncomfortable amount of ongoing geopolitical risk.

China continues to be a worry for us. While the slowing economy has certainly been recognized by markets, the extent of bad loans and hidden leverage in the banking system has the potential for catastrophe. The Chinese economy has yet to fully digest the massive credit expansion thrust upon it by policy makers after the global financial crisis. The middle kingdom could find a way to muddle through, but systemic risk is high.”

In IVA Funds Annual Report, Charles de Vaulx and Chuck de Lardemelle mention, “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.”

In Third Point’s fourth quarter 2013 investor letter, Daniel Loeb believed Japan would be a high-beta trade. Gains would be driven by BOJ policies and potentially by Japanese citizens investing in the markets in anticipation of inflation. Both scenarios, however, faced a road block in the form of the increasing consumption tax. He expected continued growth and stability in China.

We reviewed the U.S. market valuations and the expected return and found that the U.S. market is expected to return 0.9% to 2.3% a year in the upcoming years. The global market provides a totally different picture. The returns in some countries show as being much higher.

The details of the how to estimate the future market returns of the global market, the data sources, the interpretation of data have all been discussed in great details 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 the emerging market 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 have better future returns is higher for these markets that are traded below historical means than for those that are traded above.

As of April 4, 2014, the expected returns for the global market are shown in the chart below:


Among developed countries, Singapore has the highest expected market returns. Australia sits in the second place. Spain ranks in the third place. 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 36.2% a year.

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

Projected Annual Return

April 4, 2014

March 6, 2014











































Emerging Market

April 4, 2014

March 6, 2014



















From the above table, we can see for the developed countries, all the projected annual returns reduced from March 6, 2014 to April 4, 2014. For the developing countries, only Russia and Mexico’s projected annual returns increased a little during that period.

Three factors decide the expected returns of the market. They are economic growth, dividend payment and the 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, US and Germany markets are negative because these stock market 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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