Financology readers are by now familiar with our negative outlook on stocks, both on technical grounds (SS), valuations and fundamentals (discussed more fully in the Comments under Synthetic Systems 2022.75). But they are also familiar with our views on the importance of diversification, both within and between asset classes. So while we may want to keep a lid on our stock exposure, we likewise avoid having none at all.
Synthetic Systems is, while not infallible, completely objective. Our subjective impressions are no less infallible, but that that’s never stopped us from discussing them before.
One area of the stock market that appears to be getting interesting is best defined not by where it is, but where it isn’t. The latter being the United States of America. When we look at the global stock market, we see a picture of overvaluation. But this overvaluation is overwhelmingly concentrated in the USA.
Why? The world is a mess. Most of it, notably Europe and Japan, has labored for years under even more reckless monetary and fiscal policy than the US. Problems in the UK are making headlines. China labors under its Covid Zero policy. War plagues eastern Europe. War in China and Taiwan is being openly discussed. The US, even with all its problems, has been viewed as a safe haven for global capital. This has widened an already broad valuation gap between equities in the US versus the rest of the world. Finally, the strength of the USD has this year made almost everything outside the US cheaper for dollar spenders.
Let’s take a look at some numbers (“subjective” doesn’t mean we’re not allowed to look at numbers). The yield on US stocks, as measured by the comprehensive fund VTI, is given as 1.73%. The rest of the world, as measured by the fund VXUS, is given as 4.20%. This is the past year’s dividends divided by the latest price. Emphasis on price, because the dividends represent actual cash flows. In other words, in two groups of thousands of securities each, investors today paid nearly two and a half times as much for each dollar of cash flow in their pockets. Considering dividend focused funds, DNL is quoted with a yield of 5.20%, and another fund, IQDF, carries a yield of 8.85%, impressive for funds that are not specialty “high yield” vehicles, but carry widely diversified portfolios of stocks selected for growth, quality and dividend sustainability.
As we’ve acknowledged, stocks outside the US are cheap for good reasons. If for instance nuclear war were to break out in Europe, those dividends are likely to fall off a cliff. Of course US dividends would decline too, even assuming it were something regionally contained. Not to mention that in such an event your investment portfolio might not top your list of concerns.
But what if things don’t go so horribly wrong?
We also have to acknowledge that it’s unlikely that US stocks would precipitously fall in value while the rest of the world’s went unscathed. Adjustments in relative value historically occur through one rising more than the other or falling less, or both. So by no means am I suggesting that ex-US stocks haven’t yet bottomed, merely that the potential longer term returns better justify the nearer term risks. And … at yields like these, you can make a good case for owning them and getting a decent dividend return without having to speculate so much about what you might eventually sell them for.
We’re on record as favoring bonds over stocks over the next few quarters. It’s in this area that the US looks more attractive than its global counterparts. Most of the US Treasury yield curve is over 4%, and the issuer of the US dollar, aka the Federal Reserve Note, is at least at present one of the most firmly committed in the world to maintaining the value of the securities it issues. Again a situation where you can get at least some significant portion of your money back just for holding the position.
Every investor has different circumstances and goals, so if you’re looking for a one-size-fits-all portfolio, you won’t find it here. But given these observations, I am overweight bonds relative to stocks. Within bonds, overweight the US relative the rest of the world. Within stocks, underweight the US relative the rest of the world. In disclosure, I have positions in VXUS, IQDF & DNL.
8 thoughts on “Where In The World Are The Cheap Stocks”
Quick comment on the short term … the September CPI report is due out tomorrow morning and could be a major market moving event either way. A soft report could send both bonds and stocks soaring, while a hot report could have the opposite effect. Unless it were a huge surprise, though, I wouldn’t read much longer term significance into it.
The markets appear to underappreciate the degree to which the Fed is relying on “financial conditions”. In Fedspeak, this means asset prices. It’s not that the Fed is about to ignore traditional econometric statistics like employment and wage and consumer price data, but they are lagging data and the Fed knows it. So while it’s waiting for confirmation, in the meantime asset prices have become its proxy for progress on inflation.
So even if CPI comes in a little light, if it ignites a rip in stock prices, expect the Fed to throw cold water on it. Remember what Powell did at Jackson Hole.
Well the CPI came out on the high side of expectations, prompting an immediate plunge in stocks. Eating my own cooking, I took advantage and added to my positions in foreign stocks. I did not expect however the rip-roaring rally that followed.
This is all double trouble for the Fed.
First, progress on tamping down consumer price growth is painfully slow. To put perspective on it, from June to September the YOY CPI increases ran from 9.1%, 8.5%, 8.3% to 8.2%. This is trending in the right direction, but still very high and not nearly fast enough for a Fed worried about inflation becoming “entrenched”, especially given that so-called “core” inflation remains resistant and the labor market remains in historic demand surplus.
Second, for a Fed that views “financial conditions” as a primary transmission channel for policy, soaring stock prices only throw gasoline on the fire. The last thing it wants to see is both consumer prices and stock prices shooting heavenward. On a day like today, Powell must be pulling his hair out.
It can’t last. The Fed will hike until something breaks. And the headline making turmoil seen in international currency and bond markets isn’t it … when something really breaks, the stock market will not be going up.
So pencil in another 75bp for November 2. And for the next meeting, and the next … until stocks crater.
The latest GMO seven year outlook:
GMO’s classification is odd because it breaks out “emerging value” as a separate asset class but not for other geographical regions. Not to mention “value” not a well defined classification itself. But you can put the two bars for US stocks together and the three for non-US stocks and compare them as two categories … the contrast is striking.
From Richard Bernstein of Richard Bernstein Advisors:
A Menu Of Global Opportunities