In a previous article, I argued that despite the coronavirus-induced decline in the last week of February (2020), U.S. stock markets were still grossly overvalued. This was based on two GuruFocus market valuation tools: the Shiller P / E ratio and the Buffett indicator.
However, if the markets in one country are overvalued, it does not necessarily mean that the markets in all countries are overvalued. This was a point Mebane Faber made in his book Global Value: How to Spot Bubbles, Avoid Market Crashes, and Get Big Returns on the Stock Exchange. In the book he wrote: While the US CAPE rate signals caution, similar CAPE rates signal opportunity for the equity markets of countries around the world. Using the CAPE quota to identify the most attractive countries and regions in the world can produce impressive results. The book was published in 2014, but its content is just as relevant today.
Another GuruFocus tool for analyzing market valuations is the Global Stock Market Valuations and Expected Future Returns page:
This is a variation on the Buffett indicator, which measures the ratio between a country’s total market capitalization and its gross domestic product (GNP). This allows for an easier bar graph comparison of the expected future returns of different countries.
The interpretation of the diagram is straightforward. At the bottom of the chart you can see a reference to the US where an investment is expected to return -2.1% based on current market valuations. Yes, this is a negative number, which means that the total return on the market is a loss, not a gain.
At the very top of the graph is Singapore, where the implied annual return is 16.5% based on the current relationship between Singapore GNP and its total market capitalization. In other words, if you invest in the Singapore market in the early March 2020 conditions, you are more likely to make a healthy profit. By comparison, it would be far more difficult to generate a positive return on investment in the US stock market.
To be clear, these are results for the entire market based on baskets of stocks from each country as opposed to individual stocks. You could end up picking stocks in the Singapore market that are losing money, just as you find individual stocks in the US that can still make profits despite the general overvaluation. All in all, buying an ETF that represents the Singapore market would be a better new investment than buying an ETF that currently represents US stocks.
Buying market ETFs from other countries, especially those that are hedged against currency risks, is one way of investing in global markets. It’s also often easier and less risky than investing in individual stocks. Finally, stock picking in other countries can pose additional risks, including:
- Currency Risks: When investing in a foreign country, start with the exchange rates between your home currency and the currency of the country you are investing in.
- Political Risks: Anyone considering investing in a country like Russia should read Bill Browders’ book, Red Notice: A True Story of Big Finance, Murder, and One Man’s Fight for Justice, which describes how investing in this land literally resulted in murder. In countries with well-established laws, there can even be political risks to a certain extent. For example, investing in the UK today means risking the volatility of Brexit.
- Liquidity Risks: The US markets are huge compared to the markets of other countries. Smaller markets may have less liquidity, although liquidity can vary within individual stocks.
There are also unique rewards for global investments:
- Diversification: The greatest reward for many investors is finding markets that have little correlation with their home markets. As the financial world continues to globalize, the benefits of diversification may diminish, especially in major recessions. Some suggest that global diversification was of little value during the 2008 financial crisis.
- Growth: We have all seen these extraordinary GDP growth numbers for emerging economies like China. This GuruFocus chart shows the implicit returns of some faster growing economies:
Investing in global markets means facing many advantages and disadvantages, but going through this process should expand our knowledge and make us less prone to rookie mistakes. There are a few possible solutions that we can use to avoid most of the complications.
First, we can invest in global stocks by buying ADRs, or American Depository Receipts, a form of stock security that allows foreign stocks to trade in US financial markets. Charles Sizemore of Sizemore Capital Management wrote a helpful article about her for GuruFocus in 2012.
He asked what BMW (BMW3, Financial), Burberry (BRBY, Financial) and Prada (1913, Financial) all had in common at this point, indicating that they were all ADRs. He wrote: The shares trade in US dollars and pay dividends in US dollars. Aside from the occasional withholding of foreign dividends for tax purposes, a US investor will generally find no difference between holding an ADR and holding a regular US stock.
A second way to invest in global stocks is to buy stocks that are well represented in overseas markets. For example, Statista shows this breakdown of Coca-Cola (KO, Financial) income in 2019:
Note the revenues from the global soft drinks markets sufficient to become an international stock.
U.S. markets may still be overvalued despite the correction that came in response to the coronavirus epidemic, but other markets around the world may not.
As we’ve seen, the implied returns of both developed and emerging markets are showing positive returns, suggesting that these markets are less or not overvalued at all.
To access these returns, investors may need to take additional risks which in some cases may be justified. However, there are alternative investment vehicles, including ADRs and domestic stocks, with many overseas operations that can potentially generate robust, low-risk returns.
Disclosure:I do not intend to make any specific recommendation to buy any other country ETF, ADR, or domestic stocks with foreign exposure. Investors should only invest in these securities after their own due diligence.
Read more here:
Not a premium member of GuruFocus? Sign up for a free 7-day trial here.