Where is the Next Rising Tide?

Table 1											Implied Upside as PE Returns to Ave
	2009	Est 2010	Reported 2009		Consensus 2010		Soledad 2010		Average PE		Current		Soledad		Consensus
Index / Country	Returns	Yield	EPS	PE	EPS	PE	EPS	PE	5 Yr	10 Yr	5 Year	10 Year	5 Year	10 Year	5 Year	10 Year
DJ Euro^	27%	4%	179	16	253	11	227	13	14	31	-16%	95%	7%	147%	19%	174%
Greece	26%	5%	191	11	214	10	182	11	15	16	35%	48%	28%	41%	51%	66%
Spain	38%	5%	901	12	999	11	899	12	13	18	4%	47%	4%	47%	15%	63%
UK	28%	4%	249	23	455	12	409	14	25	31	10%	36%	81%	123%	101%	148%
S&P 500	26%	2%	62	18	78	15	70	16	17	20	-5%	11%	7%	25%	19%	39%
Russell 3000	28%	2%	33	20	44	15	39	17	18	21	-9%	6%	7%	26%	19%	39%
Vietnam~	60%	na	42	12	39	13	29	18	22	na	44%	na	19%	na	39%	na
China*	99%	2%	123	26	198	16	159	21	27	na	2%	na	31%	na	64%	na
Germany	24%	4%	215	27	461	13	415	14	22	27	-20%	0%	55%	94%	73%	115%
MSCI EAFE	32%	3%	47	32	104	15	93	16	19	32	-41%	-1%	17%	94%	30%	116%
France^	28%	4%	262	15	317	12	286	14	13	14	-13%	-6%	-5%	2%	6%	14%
Canada	35%	3%	548	22	772	16	695	17	17	20	-22%	-8%	-1%	16%	10%	29%
ACWI x US	42%	3%	9	28	17	14	15	16	18	25	-36%	-9%	11%	58%	23%	76%
Hong Kong	57%	3%	1081	19	1533	14	1227	17	16	17	-19%	-12%	-8%	0%	15%	25%
Brazil^	83%	3%	3549	19	5070	14	4056	17	13	16	-34%	-19%	-24%	-8%	-5%	15%
Asia Ex Japan	72%	3%	21	22	34	14	27	17	15	16	-30%	-25%	-10%	-4%	12%	19%
Mexico	46%	2%	1739	19	1989	16	1591	20	14	13	-24%	-29%	-30%	-35%	-13%	-19%
India	83%	1%	668	25	823	21	659	26	20	18	-23%	-29%	-24%	-30%	-6%	-13%
Russia^^	125%	2%	71	20	167	8	134	11	10	9	-51%	-55%	-8%	-15%	15%	6%
Japan**	21%	2%	-62	nm	292	36	262	40	30	76	nm	nm	-25%	92%	-17%	114%
Source: Bloomberg  Data as of March 5, 2010
^ 10 Yr PE Ave 01-09
* PE info starts in 05.
** 5 Yr Ave (03/04-03/09), 10 Yr Ave (12/00-12/08)
^^ 10 Yr Ave (12/02-12/09)
~ 1/20/06 - 12/31/09

 

Emerging markets such as Russia and Brazil are dominating headlines because of their strong projected economic growth potential.  However, our 2010 global Price to Earning (PE) analysis suggests that long term patient value investors may still find winners in the old world, developed countries.

 

We compare the current and forecasted PE levels of major global stock markets to their 5- and 10-year averages while also adjusting for prevailing conditions.  (Table 1) Specifically, this analysis seeks to shed light on the question, “Where is the next rising tide?”  The valuation of a stock market may experience periods of low and high PEs, in other words, periods of under and over valuation.  At some point, however, the valuation reverts to its long-term average.  Like water seeking low ground, a market with a low PE will typically in due course attract an increasing amount of global capital.  As capital flows in, the market as a whole appreciates.  Patient investors who hold solid companies in these undervalued markets should over time be rewarded with significant performance through returns of both the underlying market and of the individual company. 

 

The S&P 500 and Russell 3000 seems closer to fair value than Europe though there may be some room left to appreciate.  Interestingly, the Russell 3000, which includes mid and small capitalization stocks, seems less undervalued than the S&P 500.  This could mean that the remaining undervaluation in the US may be predominantly in the large caps.

 

Europe presently could be a very good place to find compelling investments.  Relative to its 10-year average PE, the Dow Jones Euro benchmark could deliver over 90% upside from current PE level and over 140% from our estimated 2010 PE.  Within Europe, Spain and Greece standout with potential upside of approximately 50%, with the UK market at 36%. 

 

At the opposite extreme lie several emerging markets.  The Russian market could be facing a decline of over 50% since its current PE is trading at a steep premium relative to its 10-year average.  Asia Ex-Japan, Mexico and India are clustered together at about a possible 30% correction.  

	Implied Upside as PE Returns to Ave
Table 2
	Current PE
Index / Country	5 Year	10 Year
Vietnam	44%	na
India	-23%	-29%
Mexico	-24%	-29%
Asia Ex Japan	-30%	-25%
Brazil^	-34%	-19%
Russia^^	-51%	-55%

After a tremendous year in 2009, it is not surprising to see that several of the emerging markets look overvalued relative to its long-term historic PE average.  One can argue that perhaps the 10-year PE average does not properly reflect the change in risk premium and economic growth of these markets in the last several years.  In that case, using the 5-year averages may be more sensible.  Even relative to its respective 5-year averages, however, the individual emerging markets are trading at a large premium. (Table 2)  This may be a reflection of the current enthusiasm for investing in emerging markets.  The outlier is Vietnam, which looks undervalued trading at a current PE of 12x as compared to its historic PE average of 24x.

 

Table 3	Implied Upside as PE Returns to Ave Soledad Est
Index / Country	5 Year	10 Year
DJ Euro^	7%	147%
UK	81%	123%
MSCI EAFE	17%	94%
Germany	55%	94%
Japan**	-25%	92%
ACWI x US	11%	58%
Spain	4%	47%
Greece	28%	41%
Russell 3000	7%	26%
S&P 500	7%	25%
China*	31%	na
Canada	-1%	16%
France^	-5%	2%
Hong Kong	-8%	0%
Asia Ex Japan	-10%	-4%
Brazil^	-24%	-8%
Russia^^	-8%	-15%
India	-24%	-30%
Mexico	-30%	-35%

Also, in light of the present state of depressed global earnings, it could be argued that current PE is not representative.  Depressed earnings would make the current PE ratios peculiarly high.  Based on this line of thought, a more reasonable perspective would be to look at forward PE.  For example, Germany’s current PE is 27, while its forward PE is 14.  Relative to its 10-year average, the current PE suggest that the German market is fairly valued.  Its forecasted PE, however, seems to indicate it is undervalued with a potential upside of 94%.  Table 3 highlights how the individual markets look based on Soledad’s forecasted PE.  While Europe still looks the most compelling, Japan and the US are now more attractive.

 

This analysis could be used as a starting point to look for attractive long term investments.  While emerging markets may have captured investors’ attention because of their projected economic growth potential, we think developed countries may be a source for compelling investments for long term patient value investors.  Though this is an analysis based on stock markets, it does not preclude the possibility of pockets of value in seemingly pricey markets like Mexico or even Russia.  This does suggest, however, that there may be meaningful tail-wind for individual companies as the respective markets as a whole return to its long term PE average.   

 

Disclaimer

 

This publication is for information purposes only. Past performance is no guarantee of future results. While the information and statistical data contained herein are based on sources believed to be reliable, we do not represent that it is accurate and should not be relied on as such or be the basis for an investment decision. Any opinions expressed are current only as of the time made and are subject to change without notice. Soledad Investment Management (SIM) assumes no duty to update any such statements. The views expressed herein are solely those of the author and do not represent the views of SIM as a firm or of any other portfolio manager or employee of SIM. Any holdings of a particular company or security discussed herein are under periodic review by the author and are subject to change at any time, without notice.  This report may include estimates, projections and other "forward-looking statements." Due to numerous factors, actual events may differ substantially from those presented. This publication is not to be used or considered as an offer to sell, or a solicitation to an offer to buy, any security. Nothing contained herein should be considered a recommendation or advice to purchase or sell any security. SIM, its officers, directors, employees or clients may have positions in securities or investments mentioned in this publication, which positions may change at any time, without notice.  International investing involves special risks, such as political instability and currency fluctuations.  Investing in emerging markets and frontier markets may accentuate these risks. Investment return and principal value will fluctuate and it is possible to lose money by investing. You should consider a fund's investment objectives, risks, and charges and expenses carefully before you invest. 

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