Market History

Using the past to rationally predict the future.

Investors are buying foreign stocks, but doing so won’t push U.S. stocks down

CNBC ran a piece titled “the great rotation: why investors are suddenly buying European stocks and dumping American stocks”. This idea is nothing new. Great investors and fund managers have been urging American investors to buying foreign stocks – European and emerging markets – since January 2017. Their reasoning is sound and simple:

  1. U.S. stocks will go up because the U.S. economy is growing and some of Trump’s pro-growth policies will be approved by Congress.
  2. However, U.S. stocks will go up less than European and emerging market equities, which are relatively undervalued compared to U.S. equities
  3. We are now in the final few years of the current economic expansion. The world economy will go up together, so all stock markets around the world will rise in unison.
  4. It is now safe to buy European and Chinese stocks. This was not the case before 2017. The European economy was sinking slowly from 2013-2015. China’s economy was deteriorating from 2012-2016. Now that both of these economies have made a soft landing, it is safe to buy their stocks. And since these equity markets are relatively undervalued compared to the U.S., they will probably go up more than the S&P 500.

Exactly how relatively undervalued are foreign equity markets? We can compare via several methods:

  1. How much is the market above its 2015 high?
  2. How much is the market above its 2009 low?
  3. What is the P/E ratio for that country’s main stock index?

Let’s take a look at several countries.

China

China’s Shanghai Composite:

  1. 37% BELOW its 2015 high.
  2. 93% above its 2009 low.
  3. A P/E ratio of 18.8

As you can see, China isn’t that cheap from a P/E ratio perspective. This is because although Chinese stocks have fallen a lot from their 2015 highs, their earnings have fallen significantly too.

Russia

Russia’s MICEX index:

  1. 8% above its 2015 highs.
  2. 90% above its 2009 low.
  3. A P/E ratio of 9.2

Russia’s P/E ratio is significantly lower than that of China’s and most European stock markets.

Germany

Germany’s DAX:

  1. DAX is right below its 2015 highs!
  2. 241% above its 2009 low.
  3. For a developed nation, DAX has a relatively low P/E ratio of 13.5 (12 months forward earnings)

Canada

Canada’s S&P/TSX:

  1. Like Germany, S&P/TSX is right at its 2015 highs.
  2. 108% above its 2009 low
  3. S&P/TSX has a very high P/E ratio. It’s trailing P/E is 27 (very similar to the U.S.’).

UK

The UK’s FTSE 100:

  1. Merely 2% above its 2015 high.
  2. 110% above its 2009 low.
  3. The UK has a very high P/E ratio of approximately 34.

For comparison, the U.S. S&P 500:

  1. 10% above its 2015 high
  2. 254% above its 2009 low
  3. A P/E ratio of 26

Conclusion

As you can see, the U.S. is relatively expensive compared to certain developed countries such as Germany and certain developing countries such as Russia (from a P/E perspective). However, the S&P is not wildly more overvalued.

Does this mean that you should buy foreign stocks? Probably not. We aren’t. There are several problems.

  1. It’s not guaranteed that “cheaper” stocks will outperform “more expensive” stocks. Some renown investors argue that undervalued stocks perform better, while others argue that growth stocks that are already expensive will perform better. Since there is no definitive answer to this conundrum, there is no point in buying undervalued stocks just because you think they’ll go up more.
  2. If Trump passes some of his pro-growth policies, perhaps the U.S. stock market will rally more than foreign markets?
  3. If our long term bullish outlook is wrong, all equity markets around the world will be annihilated. Right now, all stock markets are moving together. This means that investors who are buying European equities will not dump U.S. stocks heavily. Either we all die together, or we all rally for another 2-3 years.
  4. Stick with what you know. We understand U.S. stocks the best, so we do not deviate from our expertise.

The Sydney Opera House at 6 a.m.

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