Global Market Valuations And Expected Returns - October 7, 2014

The U.S. bull market has lasted for 67 months up until now, and it is the fifth longest bull market in history. The market went higher during the last few years despite concerns that the market has already reached the top, yet a recent fall had investors worried. Has the U.S. stock market reached the turning point?

What is the situation in the other parts of the world? In September, among the key indexes in Europe, Germany’s DAX index lost 2.89%. France’s CAC-40 index went up slightly by 0.04%. The FTSE 100 index gained 0.80%. Stock market performances in Asia were dynamic. Japan’s NIKKEI 225 gained 4.86%. Hong Kong’s Hang Seng Index lost 7.31% and China’s SSE Composite index surged 6.62%.

In Invesco European Growth Fund’s Second Quarter 2014 Commentary the company said, “From a broad market perspective, European valuation levels appear favorable relative to other regions but earnings have yet to see a normal recovery from the recession. Japan’s correction so far this year has improved valuations, but critical structural reforms in Japan may prove to be elusive in the near term and quality opportunities remain scarce. Emerging markets began to show signs of stabilization, which has increased focus on the region, but most emerging market economics remain fragile, and economic recovery across the region is expected to be in consistent. In sum, we continue to believe that improvements in broad corporate and economic fundamentals are struggling to keep pace with rising expectations for economic acceleration in the second half of 2014.”

In Leith Wheeler Canadian Equity’s Q2 2014 Review, it said “The Canadian stock market has enjoyed healthy returns over the past several years. However, it is worth noting that on June 18, 2014, the TSX Composite Price Index finally regained its previous record close set six years earlier in June 2008. So despite the prevailing sentiment that the current bull market might be long in the tooth, the reality is that we have only just recovered from the market decline of 2008 and 2009. The TSX Composite Index continued its strong performance in the second quarter of 2014, rising 6.4%. Global equity market performance was also generally robust, as investors gained confidence in the U.S. economy and a European recovery, while fears of an emerging markets meltdown faded. Faced with very low interest rates and supportive economic news, investors continued to view equity assets as attractive and pushed prices higher.”

In Bernard Horn’s Polaris Global Value Fund 2Q 2014 Message to Our Shareholders, he said “Although we appreciate the global market gains over the past few quarters, we are concerned that such upward mobility may be partially due to greater liquidity and loose central bank monetary policy. The Bank for International Settlements noted that such fiscal policy could create asset bubbles and increase debt harmful to long-term economic prosperity. We concur with this assessment, and are careful to identify signs of economic weakness, including the recently contracting U.S. gross domestic product and slowing development in select Asian markets. We also see pockets of growth throughout the world, with marginal improvements in some European countries, India, China and select emerging markets. Even the U.S. has positive indicators (rising home sales and better U.S. manufacturing activity) that we believe may indicate sustainable momentum. However, these macro-economic conditions do not drive our investment approach. Our main focus remains on fundamental analysis – seeking to identify the most undervalued stocks that may be capable of growing stronger in difficult economic environments, while performing admirably in growth cycles too.”

In MS Global Franchise Fund’s Second Quarter 2014 Commentary, it mentioned “Five years of central bank action have contributed to a world of high valuations across asset classes. In the equity world, bears point to the elevated CAPE ratio (cyclically adjusted price-to- earnings (P/E), calculated on the last 10 years inflation-adjusted earnings, also known as the Shiller P/E) and the related high level of corporate profitability. The current levels of the CAPE ratio in the U.S. (currently at 26 times, versus the long-run average of 16 times) have historically been associated with low medium to long term returns, while corporate profits’ share of gross domestic product (GDP) has mean reverted in the past. Bulls suggest that corporate profits can remain strong, as labor’s bargaining power and government’s taxing power are both structurally impaired, and that valuations look reasonable, if you just compare them to the post-1990, post-Cold War world. We remain nervous about the equity rerating that has occurred since late 2011, adding 60% to the MSCI World Index, with no increase in prospective earnings, just as we are cautious about the prospective returns on bonds, starting from such low yields. Nevertheless, it is quite possible that both asset classes do fine for a while yet – after all, the equity market was arguably overvalued as early as 1996. While we are unclear about the direction for the market as a whole, we are clear in our belief that high quality equities, for a couple of notable reasons, are a refuge in a world where decent prospective returns are tough to find.”

We reviewed the U.S. market valuations and the expected return, and found that U.S. market is expected to return 1.0-1.5%% 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 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 or have unanswered questions.

Please note that there are large errors in predicting the future returns of 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 are higher for these market that are traded below historical means than for those that are traded above.

As of October 7, 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 16.5%. 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 34.7% a year.

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

Three factors decide the expected returns of the market: 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 Korea, Sweden, Canada, UK, Switzerland, USA, and Germany markets are negative because these stock market in these countries are traded above historical means. For developing countries, India, 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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