End-of-year portfolio rebalancing time.
What about this being the year of buying foreign stocks, especially emerging markets?
From a banker friend:
Since coming out of 2008/2009 the place to be has been US stocks, and more specifically US Large Cap growth stocks. On a relative basis US has outperformed International for something like 8 out of the last nine years. Last year, International and Emerging markets shined. That being said, if you look back to the period between around 1999 through 2007 International was the spot to be.
“Emerging Markets to US valuation ratio falls to its lowest since 2008” (October 2018; Economic Times (India)) suggests that emerging markets are a relative bargain. Bloomberg, July 2018:
Profits in developing countries rival those in the U.S. The EM index’s operating margin was 14.2 percent in the second quarter, compared with 13.8 percent for the S&P 500. Profit margins were also similar — 9.9 percent for the EM index compared with 9.5 percent for the S&P 500.
Yes, U.S. companies are generating a higher return on investment than those in emerging markets, but that’s only because U.S. firms are more levered. The EM index’s debt-to-equity ratio was 99 percent in the second quarter, compared with 113 percent for the S&P 500. After adjusting for leverage, the two indexes’ return on assets, return on equity and return on capital are all comparable.
The difference, however, is that emerging-market companies are far cheaper. The EM index’s price-to-earnings ratio is 13.3 based on 12-month trailing earnings per share, compared with 21.1 for the S&P 500. That difference is even more stark when looking beyond one year. The EM index’s P/E ratio is 14.7 based on 10-year trailing average EPS, compared with 29.5 for the S&P 500.
Is it reasonable to say that most of the good stuff that could happen to U.S. publicly-traded companies has already happened? They’ve had their tax rate cut from 40 percent (varies a bit by state) to around 25 percent. They’ve had interest rates set near zero for a decade. What else good can happen that isn’t already priced into current sky-high S&P 500 valuations?
(A lot of “U.S.” companies, of course, get the majority of their growth from foreign markets and some get the majority of their revenue from non-U.S. markets (see Apple, for example). So even if the U.S. stagnates (due to migrant caravans being stalled at the border?), some of these companies can still grow at the rate of world economic growth.)
A lot of bad stuff could yet happen to American companies. The festival of deficit spending could end and taxes raised so that we’re actually paying for all of the stuff that we demand from our Great Father in Washington. Regulations that favor trade unions could be imposed. Costs of defending employment lawsuits, including regarding #MeToo accusations, could increase.
So with limited upside and plenty of downside risk, why not sell U.S. stocks and buy foreign?
If buying foreign, why not go with the investments that have been out of favor, i.e., emerging markets? The Vanguard FTSE Emerging Markets ETF (VWO) tracks the “FTSE Emerging Markets All Cap China A Inclusion Index.” More than half of this index is China, Taiwan, and India. If you like to “buy on bad news,” you’ll be cheered to see 10 percent Brazil and South Africa in the index as well! (I’m hugely negative on South Africa’s economy; a growing population and fixed natural resources do not add up to a bright future as far as I can tell.)
Europe seems to be messed up, but maybe it would make sense to buy German and English stocks right now? The scary news about Brexit should already be priced into English currency and share prices. The news about Germany having been turned into a migrant camp should also already be priced in (and maybe it is bad news for Germans, who will be poorer per capita and suffer from more crowding and traffic jams, but is it bad for a Germany company?). I would be happy to buy Estonian securities. I have full confidence in that economy! (see https://philip.greenspun.com/blog/2016/08/01/estonia-tough-campaign-stop-for-bernie-sanders/) What is there to buy, though? The whole country has half the population of metropolitan Boston.
Readers: What do you think? Sell some U.S. stuff as soon as there is euphoria from the Federal government being restored to full operation and buy emerging? The professionals seem to recommend roughly 45 percent non-U.S. holdings for long-term investors.
All of the facts you identify are well known, e.g., the pe ratio of stocks in emerging markets, the good stuff in the US has already happened, and so on, and there is no accepted theory in economics that you can earn an excess return (return in excess of the risk assumed) by following generally known facts (except because of randomness (luck)) because these facts are priced in to whatever the stock price is. There are lots of objective reasons why equities in Europe and places like China, Russia, and Brazil should be priced the way they are — otherwise they would be priced differently. But time will tell. Probably best to just buy Vanguard Total World (VT), take whatever return the global capital markets offer and ignore the rest of these issues because it is not possible to consistently comprehend them better than the market.
Europe feels structurally weaker than the US to me. Demographics are poor, the Euro is destabilizing, and they have all our spending problems but worse. And they’re so desperate to chastise the UK for Brexit they might set off a crisis by accident (c.f. 100 years ago).
India and Japan seem very linked to exports. If the US sneezes they’ll get a cold, no? China’s market has negative transparency—the craziest conspiracy theories people have about the Fed here are likely true over there. And if things get weird how much do you think they’re going to care about foreign investors?
Jack’s analysis is pretty much QED material.