Policy Adjectives
The big news this week was that the Fed dropped its pledge to be “patient” in raising interest rates. The Fed wants to get the market used to the idea of higher rates sometime in the not so distant future.
But just so you are clear on how valuable this “forward guidance” is, Fed chief Janet Yellen later told reporters, “Just because we removed the word patient from the statement doesn’t mean we are going to be impatient.”
Patient and impatient are not the only possibilities. In between is a vast space in which one can get things done, but without being in a hurry about it. Besides, we can think of many other adjectives that far better describe Yellen’s position – fearful, ignorant, conceited, arrogant, trapped …
The markets in thrall to Ms. Yellen’s language games
Photo credit: Bloomberg
A Gloomier Outlook
Yellen will keep interest rates ultra-low not because she is patient or impatient, but because she’s afraid of what may happen if rates rise. She knows the outlook for the US economy is getting gloomier. It lowered its forecast for 2015 GDP growth (to between 2.3% and 2.6%). It also lowered its forecast for consumer price inflation. The Fed expects the inflation rate to slow to as low as 1.3% this year.
What would happen to the stock market if the Fed suddenly decided to let savers earn some real yield? We don’t know. Neither does Janet Yellen. But Mr. Market has become accustomed to free money. Like a young adult still living with his parents, he is likely to become indignant if he is suddenly asked to do his own laundry.
And so, the mollycoddling and spoiling of the financial sector continues. The meltdown will have to come later.
The Atlanta Fed’s “GDP now” measure has in the meantime declined to just 0.3%, which is way below the range of economists’ forecasts.
Where’s Cheap Now?
But last time, we promised to tell you where to find value in the investment world. We will not disappoint you. Long-suffering readers will know that your major investment decision is where to put your money.
As study after study shows, asset allocation, not stock selection, is what determines most of your investment returns. And if you’ve been following Chris’s Market Insights, you’ll also know that the market most likely to give you a healthy return going forward is the one that gave you the weakest and most disappointing returns looking backward.
That’s because high past returns typically mean an asset has become more expensive relative to its intrinsic value. And low past returns typically mean an asset has become cheaper. And the idea is to buy low and sell high, not the other way around.
Today, we put the two together, turning to an old friend who writes at OfWealth.com under the pen name Marco Polo:
“We can’t know with any certainty exactly how much profit any one company or group of companies will make in future years. But we do know how the current price of a company’s shares compares with its recent finances.
Is the price high or low? To figure that out, you need to look at it from several directions.”
And the Winner Is …
Our friend looks at the 12-month trailing price-to-earnings (P/E) ratio, the dividend yield and the price-to-book (P/B) ratio.
Measured by P/E this indicates that Russia (6.7), Italy (8.5), China (10.1) and Greece (8.1) are cheapest and Spain (22.3), Portugal (20.6), Canada (20.6), Switzerland (20.6) and the USA (20.3) are the most expensive.
Using dividend yield the bargains appear to be Russia (5.7%), Brazil (4.8%), Spain (4.6%) and Portugal (4.3%), and the worst yields are available in Greece (0.7%), Japan (1.7%), India (1.5%) and the USA (1.8%).
By [the price-to-book ratio] both Greece and Russia are trading below liquidation value, both with P/Bs of 0.7. Put another way, at the end of December there was 43% upside to liquidation value in both markets (1 divided by 0.7 equals 1.43, or 143%).
That indicates an extreme bargain in both cases. Earnings can swing around from year to year, but book values are much more stable.
Our friend also looks at the Shiller P/E (aka the CAPE ratio or P/E 10). This compares today’s share price with the average of the past 10 years’ earnings after adjusting for inflation.
By this measure there are four “cheap” markets with P/E 10s less than 10. Those are Russia (4.6), Brazil (8.8), Portugal (6.3) and Greece (2.4). At the expensive end, over 20, we find India (20.3), Switzerland (23.1), Japan (25.9), Indonesia (26.6), the USA (27.8) and Italy (29.6).
Who’s the winner?
Russia. It is cheap on all measures. It gives you the most value you can get. And where do you get the least value? “Only one country is expensive on all measures,” concludes our friend. “The USA.” A simple investment formula: Sell the US. Buy Russia.
In ruble terms Russian stocks have recovered smartly from their 2013 lows – however, they trade at far lower levels in dollar terms, as the ruble has declined quite a bit. However, the ruble has begun to strengthen significantly in recent weeks – click to enlarge.
The RTSI index makes the difference clear: this is essentially the same index in US dollar terms. From the perspective of dollar based investors, Russian stocks are also nominally trading at very low levels. The recent rally may not look like much on this chart, but was actually quite sizable in percentage terms (from below 600 to 862 points is a gain of approx. 44.5%) – click to enlarge.
