Where in the World Should You Invest?

A discussion of international markets

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Jan 18, 2017
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The world is a big place, especially for investors. It makes a lot of sense to invest outside of your home market and investment professionals always recommend such a strategy, but it is hard to implement when there are tens of thousands of stocks out there.

By diversifying into international markets, investors can gain access to faster-growing economies as well as markets that may seem more attractively priced and offer more attractive dividend yields than those at home.

Expensive market

The U.S. equity market comprises 43% of the world’s total equity market capitalization. U.S. stocks are the most widely followed as a result. At the time of writing however, they are also some of the most overvalued compared to the rest of the world.

U.S. markets trade at an average forward price-earnings (P/E) ratio of 21.8 and cyclically adjusted P/E (CAPE) ratio of 26.4, the third-highest of the 40 largest equity markets in the world. Using the CAPE ratio, only the equity markets of Ireland and Denmark are more overvalued. In addition, U.S. markets offer an average dividend yield of 2%, which is the bottom fifth of yields for the 40 most important equity markets in the world.

By investing outside the U.S., there is scope to invest in equity markets with a lower overall valuation and higher overall dividend yield. But which markets are the most attractive?

The most attractive markets

Based on the CAPE ratio, the most attractive market in the world right now (limited to the world’s 40 largest markets) is Russia. The Russian market trades at an average CAPE ratio of 5.9, P/E ratio of 9.1 and price-book (P/B) ratio of one. The average dividend yield of the Russian market is 3.7%.

Next on the list is the Czech market. This European frontier market has been recommended by Wall Street in the past due to its up-and-coming status as well as improving regulation and steady growth. The market currently offers the highest dividend yield of all of the world’s 40 most important markets with a yield of 6.7% penciled in for this year. The Czech market trades at an average CAPE ratio of 9.8, P/E ratio of 13.6 and P/B ratio of 1.3.

Besides the Czech market, other attractive markets on a valuation basis are the usual suspects. Turkey, Brazil and Poland all trade at CAPE’s of 10 or less right now, but all of these countries also have significant economic and political issues.

You do not have to buy the dogs to pocket a dividend yield that is almost double the U.S. market average however. Politically and economically stable nations such as New Zealand, Australia, Finland and Norway all offer dividend yields of 4% or more on average. The one downfall is that on a CAPE ratio basis, none of these markets look particularly cheap.

Tracking a basket

If you are looking for cheap international markets but feel it would be better to pick several or invest in an index that tracks several markets, it may be better to go with a European tracker. For example, emerging European markets currently trade at an average CAPE ratio of 8.6 compared to emerging markets’ CAPE ratio of 14. Emerging Europe trades at a P/B ratio of 1.1.

Emerging Europe yields 3.4% compared to emerging markets’ 2.9% average. Developed Europe also offers more in the way of yield than emerging markets. Developed Europe as a whole yields 3.2% but trades at a relatively high CAPE ratio of 16.6.

The best option and a pick for adventurers

On average, emerging European markets may be a better bet for investors who want international diversification.

Of course, no article on emerging markets would be complete without mentioning China. Even though China is a favorite of Wall Street’s emerging market analysts, the market as a whole currently looks relatively expensive compared to other more attractive opportunities in Europe. The Chinese market trades at a CAPE of 12.8, a P/B ratio of 0.9 and supports a dividend yield of 4.2%.

Lastly, for really adventurous investors looking for something to add some spark to their portfolios, Kenya may prove to be one of the world’s best frontier markets this year. Kenyan GDP rose 5.7% during the third quarter, inflation is around 6.5% and government debt to GDP is a manageable 48%. The only macro blemish is a UK-style current account deficit. Despite these positive economic trends, the Nairobi SE 20 index is down 43% from its recent peak in March 2015 and is on a P/E of 9.5 and a dividend yield of 8.5%.

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