Global Stocks: Winners and Losers (Part 3)
As mentioned earlier, price (valuation) appreciation might be logical provided that corporate earnings have kept up (or exceeded) with that price appreciation.
When you put together price appreciation with growth in corporate profits for different global markets, you get some interesting, even surprising, conclusions.
The table below sums the results. A positive number (“Rerating”) means price appreciation has exceeded growth in corporate profits, perhaps suggesting that the market is now valued more expensively. Conversely, a negative number (“Derating”) means price appreciation has lagged growth in corporate profits, implying the market is valued more cheaply than prior to 2008.
Market Rerating (Derating)
Note: ETF’s used to calculate total return from 12/31/2007 to 9/20/2018. Total return includes price performance and dividends in US Dollar terms.
ETF’s used included EEM (Emerging Markets), EWJ (Japan), SPY (US), EZU (Europe ex-US), and EWU (United Kingdom). These are suggested proxies for the underlying equity markets and not indicative on any recommendation.
Source: ycharts.com, MSCI, T. Rowe Price, iShares, and Ambassador Wealth estimates.
The US has been the valedictorian over this decade when it comes to robust corporate earnings growth.
However, the US market has also experienced price appreciation far greater than growth in earnings. Potentially, that might be a red flag for the market. (However, we would argue that it reflects more on specific parts of the market, such as certain high-flying technology stocks, rather than necessarily a wholesale indictment of the US market overall.)
Japan reflects moderate undervaluation relative to earnings. As discussed earlier, Japan faces investor skepticism to the durability of its earnings recovery. Yet, if and as earnings continue to grow, the market might have potential to rerate, or at least hold its own in the event global markets were to sell off.
In spite of their poor performance over the last decade, Emerging Markets appear quite fairly-valued (not expensive, neither cheap) given where earnings stand. A resumption in earnings growth could help the asset class.
Europe and the UK surprisingly look overvalued relative to earnings. Indeed, on this measure, the UK is the most expensive market in the world based on markets outperforming the decline in corporate earnings. This is even worse than the US. Unlike the US, neither the UK nor Europe boasts large high-growth, high-valuation technology companies. Europe and the UK are simply victims of poor earnings.
It would take a significant recovery in corporate profits just to work off the overvaluation in these markets to bring them back to fair value. That does not rule out occasional fits and short-term rallies. However, it appears difficult for Europe to post a meaningful bull market for the time being.
We also dare not neglect the macro risks surrounding Brexit and the Euro. Europe might be swimming upstream for a while.