When I look at equity prices in Europe and emerging markets today, I’m reminded of a quote by the notorious bank robber Willie Sutton. When asked why he robbed banks, Sutton replied matter-of-factly, “Because that’s where the money is.”
If you ask me why I recommend investing in Europe and emerging markets, you’re going to get a very similar answer: Because that’s where the bargains are.
To give you an idea of the attractive valuations currently on offer, let’s take a look at the cyclically adjusted price/earnings ratio, or “CAPE.” CAPE is a variation of the traditional price/earnings ratio that uses a trailing 10-year average of earnings rather than simply using the most recent year. By taking a 10-year average, you smooth out the extremes of the business cycle and you avoid falling into value traps.
By applying the CAPE methodology to an entire market, we can get a handle on a country’s valuation, both relative to other countries and relative to its own history. For example, take a look at the following table, which ranks the countries of the world by their CAPE:
One thing should jump off the page quickly: The United States is, by a wide margin, the most expensive major market in the world. Only Denmark and Indonesia (not shown) are more expensive, and these are relatively small stock markets.
Now, I am a big believer in the American system, and I believe that the U.S. economy will grow at a faster rate than most of the developed world over time. But do I think it will grow 86% faster than, say, the United Kingdom?
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Absolutely not. Yet this is what today’s valuations are implying.
Some of my favorite markets in the world today — such as Spain, Italy, China, and Turkey — are also some of the cheapest. But investing in some of these markets — particularly in their smaller, locally traded stocks — can be difficult.
Not anymore.
Let me introduce one of my favorite ways to invest in the undervalued markets of Europe and the emerging world: The Cambria Global Value ETF (GVAL). GVAL is the brainchild of Meb Faber, one of my favorite analysts and co-founder of the Cambria Funds.
How does it work? GVAL applies the CAPE methodology to 45 major world markets, applies additional proprietary value screening, and then ranks the countries by valuation. Only the cheapest 25% of world markets make this first cut. Cambria then screens these attractively priced markets for stocks with market caps larger than $200 million and, after further screening to avoid over-concentration in any single country, produces a portfolio of 100 global value stocks.
It gets better. Only 52% of GVAL’s portfolio is invested in large-cap stocks. The rest is invested in small and mid-cap stocks. By having a smaller-cap bias, GVAL is able to dig around and find value in places that are normally very hard for individual investors to access.
That’s attractive for two reasons. First, all else equal, it should mean higher returns. As the oft-cited Fama and French data showed, small-cap value stocks tend to outperform over time. Second, in addition to the potential for higher returns over time, you’re also getting real diversification from other European or emerging market funds you might already have, as GVAL invests in precisely the kind of stocks that get under-weighted or ignored entirely by the popular market-cap-weighted country ETFs.
You could make an argument for keeping a permanent allocation to GVAL. But today, given the valuation gap between the U.S. and the rest of the world, the case is more compelling than ever. I expect a global value approach to outpace the S&P 500 by a wide margin for the remainder of this decade — and probably well into the next one.
Charles Lewis Sizemore, CFA, is the editor of Macro Trend Investor and chief investment officer of the investment firm Sizemore Capital Management. Click here to receive his FREE weekly e-letter covering top market insights, trends, and the best stocks and ETFs to profit from today’s best global value plays.
