Last week in Money and Markets, I pointed out that Federal Reserve chief Janet Yellen isn’t off-base in saying stock prices are “quite high.” In fact, according to several traditional market valuation measures, stocks do look a bit pricey right now.
Don’t get me wrong, U.S. stocks are nowhere near “irrational exuberance” levels, at least not yet, but that doesn’t mean domestic stocks are screaming bargains either.
So where in the wide world of investing are stocks more reasonably priced, or better yet, even attractively undervalued?
Let’s take a closer look by surveying some of the major developed and emerging markets worldwide to help answer this question.
As I pointed out last week, there are MANY different measures of stock market valuation. And there’s no right or wrong way to go about it. But for the sake of simplicity, let’s look at price-earnings ratios (P/E) based on the bird-in-hand measure of trailing 12-month earnings for a sampling of global market valuations.
In the table to the right, you can see the trailing 12-month price-earnings ratios for several stock markets worldwide, both developed (U.S., Europe, Japan) and developing (China, Korea, Taiwan). As you can see, there is a big difference in the P/E ratios of some markets compared with others.
It’s a wide range with European stocks on the high side of the P/E range. France’s CAC 40 Index for instance is priced at 26 times trailing earnings; quite high indeed. Germany’s DAX Index is more reasonable with a P/E of 19, but still somewhat higher than the S&P 500 P/E of 18.8. Japan’s Nikkei looks pricey too with a trailing P/E ratio of 22.8, but Japanese stocks have historically high valuations. Still, I see no bargains here.
In my Money and Markets article a week ago, I pointed out that research by asset manager GMO suggests U.S. stocks are priced for negative returns over the next several years. The same is true for international stocks, including markets in Europe and Japan.
So where are the bargains? Just look at the lower half of the table above and you’ll see. Stocks in Singapore trade at just 15.5 times trailing earnings. Taiwan shares have a P/E ratio of just 14.7, and Hong Kong’s China Enterprises Index looks like a real bargain with a P/E of just 10.3 times trailing profits!
And yet, according to fund manager surveys, investors feel more comfortable stashing their money in U.S. stocks right now in spite of high valuations, and it’s easy to see why. After all, S&P 500 earnings have grown at an annual rate of 11% over the past four years. And sure enough, the S&P 500 Index has advanced 14.6% annually over the past four years as well.
Meanwhile, emerging markets profits have compounded at just 1.3 percent per year over the past four years. And most emerging stock markets have likewise languished. The MSCI Emerging Market Index is up just 30.9% since 2010, less than half the gain posted by the S&P 500.
Given these comparisons, it’s easy to see why U.S. stocks have been considered the only game in town in recent years, because that’s where investors have been best rewarded. But that’s old news now.
We must invest in the here-and-now with an eye toward future prospects, not past performance.
And here’s the key point to remember: Buying stocks on the cheap while avoiding overpriced markets is generally the most profitable strategy to follow with your investments.
U.S. stocks have indeed performed well, but can no longer be considered cheap at today’s valuation. In fact, they’re on the expensive side compared to other global markets. As I said last week, that doesn’t mean you should bail-out of all your domestic stocks, but you should be a bit more cautious, and above all selective, with the investments you own.
What it does mean, is that for NEW investments you’re considering, take a look at some of the true bargains in stock markets outside the U.S. with lower P/E ratios and the prospect of faster earnings growth.
As mentioned, stocks in Taiwan have a P/E of just 14.7, compared with 18.8 for the S&P 500. But earnings in Taiwan should grow 12.5 percent over the next year, while S&P 500 profit growth has stalled recently.
Or take a look at China. The Hang Seng China Enterprises Index is dirt-cheap at just 10 times trailing earnings, and profits are set to grow 12 percent this year. Meanwhile S&P 500 profits are going the other way, decelerating to just 2 percent growth year over year!
Bottom line: I always look to buy low valuation AND high profit growth potential, a winning combination in my book. If that’s your aim too, then consider going global with your stock selection.