Would you be brave enough to invest?

Recently, I had the pleasure of reading Meb Faber’s excellent e-book ‘Global Value: How to spot Bubbles, Avoid Market Crashes, and Earn Big Returns in the Stock market’. The book discusses the importance of value based investing in stock markets globally and for me it highlights the importance of price when purchasing shares in a business and the dangers of simply operating a strategy of buying stocks no matter the prevailing market price.

Meb Faber has utilized Robert Shiller’s development of the Cyclically Adjusted Price Earnings Ratio (CAPE) to apply it to global stock markets and the findings are illuminating. For those not familiar with Robert Shiller’s work, he expanded on the pioneering work of Benjamin Graham and David Dodd in their 1934 book ‘Security Analysis’, to create his CAPE formula and method of stock valuation, which uses the past 10 years average earnings to assess whether stocks are valued attractively or whether they are overpriced, rather than 1 year in the simpler and more commonly known P/E ratio.

The table below illustrates just how far investor sentiment and economic conditions can influence how many multiples of earnings investors are willing to pay for a business. The divergence between min/max CAPE ratios are large and illustrate the extreme levels of pessimism and optimism that frequently exist in financial markets.

So what are the investment implications of purchasing cheap stocks as indicated by the CAPE ratio? Well Meb Faber and his team at Cambria Investment Management researched historical stock market performance for 32 countries and the possible implications for your investment choices.

“We then set out to test CAPE in a similar manner. Starting in 1980 we sort all countries by CAPE, and invest in the most undervalued x%, rebalanced yearly. We also show the effects of investing in the most overvalued x% as well as a long/short portfolio. These returns are real returns net of inflation, and with yearly data (which will naturally understate drawdown figures). The sample includes approximately 10 countries in 1980, 20 in 1990, and 30 by 2000.” Meb Faber.


As the majority of financial professionals and private investors today do not tend to take concentrated stock positions, I will illustrate the portfolio that you could buy at the present time utilizing this method of the top 33% cheapest stocks based on CAPE, or the cheapest 10 markets. (I have only utilized the 32 stocks outlined within Meb Faber’s book).

The data for these 32 countries and many others can be found at www.starcapital.de/research/stockmarketvaluation.

I think people who live in a cave may appreciate the bravery necessary to invest in some of these countries! With all the newsfeed in relation to Greece and Russia in particular, it’s not worthwhile adding to the rhetoric. Some markets however, such as South Korea and Austria, do appear attractive markets available at attractive prices.

There are two main factors which outline why bravery is necessary. The first relates to news flow and the second to career risk for financial professionals.

Newsflow: Will you be able to stomach owning shares in countries where for perhaps long periods of time the news is entirely negative?

As an example, can you think of a single article that portrays Greece’s situation in a positive light?

Negative news flow can make your investment fall in value in the short term, perhaps disturbingly so. However it’s at times of the highest negative sentiment that stocks are available at their cheapest prices, simply because everyone has been frightened off and demand for the stock has plummeted.

Career Risk: Unfortunately as financial professionals who operate in a world of continuous public assessment of performance, your career can suffer substantially by taking a contrarian view. As a financial professional it’s far more reassuring to invest the same way as the majority of your fellow professionals.

So how can you invest in these cheap markets? 

One way is to invest in the Cambria Global Value ETF (USD) developed by Meb Faber at Cambria Investment Management. The ETF is an interesting investment proposition that is based on an index created using fundamental analysis, rather than size weighted indices. The Cambria Global Value Index begins with a universe of 45 countries located in developed and emerging markets. The Index next separates the top 25% of these countries as measured by Cambria’s proprietary long-term valuation metrics. The Index then screens stocks with market capitalizations over $200 million. It is comprised of approximately 100 companies. More information is available at www.cambriafunds.com.

It is part of a growing wave of interesting indices and ETFs developed utilizing actively managed investment concepts and the great thing about these ETFs is that you know exactly what you are purchasing. With traditional managed funds, you can invest and then a change of management or view could completely alter how the fund is invested, which may be at odds with your original intentions for investing within the fund in the first place.

If you wished to build this portfolio, or simply select some of these cheap stock markets, then (Russia excluded) it will be difficult to find traditional Investment Trusts and Funds in the UK to obtain the specific country exposure. With regards to Europe focused funds, many funds have too much investment in the higher valued markets of Germany for example to be able to target these cheap countries in sufficient quantity.

It is for these reasons that you would be better off utilizing country specific ETFs, or if you have the skill, resources and remit, investing in selective stocks within these countries. Below is a list of some investment choices available for the brave investor.

Country Investment Options
Greece Global X FTSE Greece 20 ETF (USD)
Russia This market has the most investment choices available with the option of the Neptune Russia and Greater Russia Funds or the JPM Russian Securities plc Investment Trust, in the traditional funds space or through the iShares MSCI Russia ADR/GDR UCITS ETF (GBP).
Portugal Global X FTSE Portugal 20 ETF (USD)
Austria iShares MSCI Austria Index fund (GBP)
Ireland iShares MSCI Ireland Capped ETF (USD)
Spain Amundi ETF MSCI Spain UCITS ETF (GBP)
Turkey iShares MSCI Turkey UCITS ETF (GBP)
South Korea iShares MSCI Korea UCITS ETF (GBP)
Sources: www.morningstar.co.ukwww.trustnet.comwww.globalxfunds.comwww.ishares.com/uk


Fortune Favours the Brave

It is clear that some of these markets are experiencing significant problems and many people would view you as foolish to invest in them. That is however part of the appeal. These perceptions cause the demand for these stocks to be low and therefore the prices are cheap, especially relative to many other stockmarkets.

The research put forward by Meb Faber in his book is compelling and I feel should warrant attention from all investors.

For the brave few, there could be some very attractive 10-year returns available.

Please let me know your thoughts in the comment section below. It would be great to hear from you directly. Simply email mark@nomadparaplanner.com and i’ll get back to you shortly.

Mark Underdown

Nomad Paraplanner