Should Investors be Considering International Markets for Investments?
Given the significant US stock market rally seen over the last few months, many US equities appear overvalued. The current S&P 500 P/E ratio is over 36, significantly higher than last year’s P/E ratio of 23.22. A P/E ratio represents the premium that investors are willing to pay for an equity relative to its earnings and a high P/E ratio usually indicates investors have optimistic expectations about the company’s future. However, given the current economic and political climate bringing such uncertainty, it may be challenging to warrant such high expectations. This may lead to the inference that stocks are overvalued based on their fundamentals, with other factors causing this high valuation rather than a company’s future. For instance, excessive bond buying from the Federal government has led to historically low bond yields. This means that the fundamentals of the underlying company have not changed, but the valuation of the company will be increased as a result of the lower discount rate applied in valuation models, leading to higher investment in equities as bonds appear less attractive investments.
Hence, for value investors seeking stocks which are undervalued based on their fundamental projections, they may decide to look in places other than the US for investment opportunities. Warren Buffet, arguably the greatest value investor of all time, has recently stated that global equities on average are currently heavily overvalued, based on the percentage of total global equity market cap relative to global GDP. This percentage currently stands at 174%, whilst a percentage of over 100% indicates overvaluation. The US stock market currently accounts for such a large proportion of global market cap, with US equities accounting for nearly 60% of the MSCI (a world index including companies from developed countries). Hence, investors are likely to look towards other regions for investment opportunities as current prices may not justify investments, and there are higher chances of good companies being overlooked by investors elsewhere.
East Asia is an area with potential investment opportunities for investors. Warren Buffet recently bought 5% stakes in each of Japan’s five largest trading houses - Mitsubishi, Mitsui, Itochu, Marubeni and Sumitomo. This move highlights the undervaluation realised by Buffet, as many Japanese stocks are currently overlooked and not favourable amongst investors. For example, Mitsubishi has only a P/E ratio of 9.5, demonstrating the lack of favouritism for this stock. Half of the companies listed in the Tokyo stock market are valued below their book value, and Japanese stocks make up only 6.5% of the MSCI, which demonstrates the potential opportunities in this area given the stable economic and political climate. Investors should seek greater opportunities outside of the US in 2020, as an upcoming election campaign, and COVID-19 not slowing down anytime soon paints the US in an uncertain light.
Another East Asian country which appears as an attractive investment for equities is China. The Chinese equity market consists of securities which appear as “anti-fragile” assets, meaning they are not as affected by ongoing global political issues relative to other assets. This characteristic, combined with the strong growth China has experienced (and is likely to continue) makes China a region which investors must keep on their radar. The Shanghai Stock Exchange Composite Index, a main capitalisation-weighted index only has a P/E ratio of 17.65, signifying the current lack of investor sentiment for these securities, considering the low premium relative to earnings currently held. Companies such as Alibaba and Tencent are essential for people living in China, and many companies based in China are essential for world supply chains. Hence many companies would be a safe bet in China as the economic future of China looks strong. The GDP growth rate of China has exceeded that of the US’ and is expected to continue this way. These Chinese companies which already have a strong global position will continue to dominate and gain greater global exposure outside of China. Alibaba currently has a market capitalisation of 744 billion USD, which is expected to grow enormously in the future as the conglomerate continues to grow globally. Hence, all investors should consider large Chinese companies to diversify their portfolio and benefit from the sizeable expected growth as these are companies that are here to stay.
By Josh Davies