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Global Stock Values: Where to Park Your Cash for the Next Five Years

U.S. stocks are looking expensive by just about any metric you want to use: The trailing P/E, forward P/E, price/sales ratio, and total market cap / GDP ratio are all well above historical averages. Any way you slice it, U.S. stocks aren’t cheap. Today we’re going to look at stock values around the world and see what those values say about future returns.

I wrote at the beginning of this year that U.S. stock values were sitting at a cyclically-adjusted price/earnings ratio (“CAPE”) of over 27 and that this implied we’d be looking at flattish returns of just 0.3% per year over the next eight years.

That estimate, made by research site GuruFocus, was based on three components: current dividend yield, expected economic growth over the next eight years, and stock values as measured by the CAPE returning to their long-term average. Like any forecast, the model is only as good as its inputs, and a lot can happen over the next eight years. Stocks could remain above their long-term CAPE valuations if bond yields remain in the gutter, or the economy could end up growing at a much faster pace than expected. Stranger things have happened. But when allocating hard-earned capital, that’s not a bet I would want to make.

Today, we’re going to look at new CAPE data through January 31 from Swiss consultancy firm Wellershoff & Partners Ltd that compares stock values across all major world markets and forecasts returns over the next five years. Wellershoff’s methodology is a little different from that of GuruFocus. Wellershoff makes no assumptions about dividend yields or economic growth. Instead, they simply look at how the markets performed over the subsequent five years when priced at similar CAPE valuations in the past. (For the quants in the room, Wellershoff runs a regression analysis. If you want to dig into the numbers, they explain their methodology here.)

So, let’s take a look at their data for developed markets first:

Developed Market CAPE and Returns Forecast

Developed MarketsCAPE sinceHistorical average CAPECAPE derived from macroeconomic variablesCurrent CAPEPredicted real return next 5 yearsPredicted real return p.a.Standard error of forecast
Hong Kong12/31/198218.816.515.965.810.64.2
New Zealand01/31/199816.917.918.516.63.13.4
Developed Markets MW01/31/198723.920.
Developed Markets EW01/31/198720.216.638.46.75.3

Most global stock values suggest solid, if not quite spectacular returns, over the next five years. A few exceptions jump off the page, however. Ireland is priced to actually lose 3.3% per year over the next five years, and New Zealand is priced to deliver returns of only 3.1%. And by Wellershoff’s estimates, the U.S. is priced to deliver a skimpy 1.5% in annual returns.

But developed markets as a whole are priced to deliver returns of about 7% per year going forward. That’s not a “fat pitch” to swing at, but it’s not bad either, particularly given how unappealing bonds and cash are at current yields.

Let’s now see what emerging markets have to offer:

Emerging Market CAPE and Returns Forecast

Emerging MarketsCAPE sinceHistorical average CAPECAPE derived from macroeconomic variablesCurrent CAPEPredicted real returnPredicted real return p.a.Standard error of forecast
South Africa01/31/197013.312.919.
Emerging Markets MW02/28/199815.715.
Emerging Markets EW02/28/199820.014.659.89.85.7

We need to view the emerging market data with a healthy grain of salt due to the shorter time horizons in question. For example, Peru’s (EPU)  historical data goes back only to 2003, a period that happened to coincide with a once-in-a-generation boom in mining. I wouldn’t consider Peru’s historical CAPE of 29.6 to be a realistic picture of Peruvian stock values. Likewise, Colombia (ICOL) has an unrealistically high historical CAPE of 34.9, also due to a short time frame that happened to correspond to a period of unusually high growth..

That said, there are some attractive forecasts here. If you can handle the heartburn that would come with ownership, Greek stocks (GREK) are priced to deliver killer returns of 22.7% per year for the next five years. Of course, you have to be confident that Greece won’t get kicked out of the Eurozone…and that risk is not something the historical figures reflect.

China (FXI), Mexico (EWW) and Turkey (TUR) are also all priced to deliver solid double-digit annual returns. But interestingly, by Wellershoff estimates, Russian stock valuations (RSX) suggest annual returns of just 7% going forward.

The usual caveats apply here: past performance is no guarantee of future results. And these forecasts are based on the past performance of these respective countries. Still, I would come away from this with one clear point: U.S. stocks are priced to deliver much lower returns than most other developed and emerging markets. To the extent you can, it makes sense to diversify and to overweight the cheaper, non-U.S. markets.

Charles Lewis Sizemore, CFA, is chief investment officer of the investment firm Sizemore Capital Management and the author of the Sizemore Insights blog

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0.3% Annual Returns: Stocks Priced to Deliver Savings-Account Returns Over the Next 8 Years

Last week in the Ahead of the Curve section of Economy & Markets, John Del Vecchio wrote about how the U.S. stock market was expensive by historical norms, using one of his favorite metrics, the price/sales ratio. A price/sales ratio above 1.26 signals danger and at 1.71 we are well above those levels today.

At ratios over 1.26, stocks are priced to deliver returns of about 0.70% per year based on past experience.

Today, I’d like to expand on John’s points using one of my favorite metrics, the cyclically-adjusted price/earnings ratio (“CAPE”). The CAPE takes the current market price and divides it by an average of the past 10 years of earnings, adjusted for inflation. By taking a 10-year average, you smooth out the booms and busts of the economic cycle.

It’s counterintuitive, but stocks can sometimes look cheap at the top of the economic cycle using the traditional price/earnings ratio when they’re actually very expensive. The CAPE smooths out this noise and gives better perspective.

For the history buffs out there, Benjamin Graham, the father of the investment profession as we know it today and mentor to a young Warren Buffett, used the CAPE extensively and wrote about it in his classic Security Analysis.


So, what does the CAPE tell us?

Well, at a CAPE of 27.3, stocks today are more expensive than they were in 2008 and about on par with their valuation in 1929. The only time in history when stocks were more expensive was the go-go bubble years of the 1990s.

Let’s play with the numbers a little. At these levels, the S&P 500 CAPE is 64.5% more expensive than its long-term average. This implies that we’ll see annual returns of about 0.3% per year over the next eight years.

This needs a little explaining. There are three components that go into the calculation: the dividend yield, expansion or contraction of the CAPE to its long-term average and underlying business growth.

The weakest link here is business growth. The assumptions made by GuruFocus here assume that business growth is in line with past averages, and that’s an assumption I’d rather not make right now given the debt, deflation and demographic issues facing the world’s major economies.

Revising business growth lower would push expected returns even lower. But for our purposes here, we’ll roll with it.


Let’s look at some scenarios. For the sake of argument, let’s say that this time it really is different and that because today bond yields are so abnormally low, they keep stock valuations artificially high. If we get lucky, and CAPE valuations don’t revert to their means, we might manage to squeak out between 2.9% to 5.2% annual returns over the next eight years, including roughly 1.9% in dividends.

But given that markets tend to overshoot, swinging from overvalued to undervalued, I think it’s more likely we’ll see the negative returns you see in the table.

In John’s piece, he noted that, unlike the 1990s, when you could actually find value outside of bubbly tech stocks, “everything” is overvalued here. And I agree.

I’d add that by one metric the market is even more overvalued today than it was in 1999. The data John and I used covered the large stocks of the S&P 500, which is dominated by a small handful of mega-cap names.

But Dartmouth professor Kenneth French recently found that the median stock—that “average” stock in the middle—is actually trading at the highest price/earnings ratio since World War II.

This piece first appeared on Economy & Markets.

Charles Lewis Sizemore, CFA, is chief investment officer of the investment firm Sizemore Capital Management and the author of the Sizemore Insights blog.

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Everything’s Fine. Just Keep Investing!

Apparently, the price you pay doesn’t matter because stocks always rise over the long term.

Or at least that was the message Barron’s sent over the weekend (see Why the Market Will Keep Climbing). Looking at stock returns back to 1871, Barron’s found that of the 139 five-year periods, only 16 had negative returns. Adjusting for inflation it was more like 25, but still a very low number. There were no 15-year stretches without positive returns, unless you adjust for inflation–in which case there were only three.  And over 20- and 30-year periods, stocks were always profitable, inflation adjusted or not.

Market Returns (1871-2014)

Nominal Stock Returns5-Year10-Year15-Year20-Year30-Year
Source: Barron's, from WisdomTree data
Number of Times Negative164000
Number of Times Total139134129124114

I read Barron’s every Saturday morning. It’s part of my regular weekly ritual, and as a general rule I find the magazine to be sober and balanced. But this is shoddy analysis, and I would argue that it’s irresponsible to print.

Where do I even start picking this apart. I suppose we should start with the time periods involved. 1871? Really?

Think about that for a minute. That’s six years after the Civil War. How many stocks traded publically in 1871, and how many Americans had access to them? The answer is “not many,” and certainly not enough to draw meaningful conclusions about returns. Assuming price data from that period is accurate–which is a stretch–stocks were not the liquid investments back then that we know today. There were no mutual funds back then…no 401k plans…and certainly no online brokers. Most Americans measured their wealth in acres of farmland owned, not shares of stock. And in any event, prior to the 1920s the United States was what we would think of today as an “emerging market,” with higher risk and higher expected returns built into prices.

Stocks did not become a mainstream investment vehicle until maybe the 1920s. The first modern mutual fund–the Massachusettes Investors’ Trust–was created in 1924. But mutual funds–and stock market ownership in general–did not really go mainstream until the 1950s. And you could make an argument that mainstream investing as we know it today started in 1978 with the creation of the 401k plan. And the regulatory regime as we think of it today didn’t exist until the Great Depression.

Being generous, we could say that meaningful data starts in the 1920s. This would mean that more than a third of the data used to build the chart above is meaningless.

And what about dividends? Dividends are included in the historical returns. The only problem is that today, the S&P 500 yields 1.88%, or less than half the 4.35% median dividend yield going back to 1871. As recently as the 1980s, dividend yields were north of 6%.

Along the same lines we have bond yields and inflation. The great bull market of 1982 to 2000 came on the back of the “great moderation” in inflation and interest rates. Now in 2015, bond yields are near all-time lows. At best–and this is the scenario I see–we could see bond yields trade sideways for several years. But they certainly can’t go materially lower from today’s levels. So, any sustained bull market starting from today will not enjoy the powerful tailwinds of falling yields that we’ve gotten used to over the past 32 years.

And finally–and arguably most importantly–we have price. Stocks today are expensive. As in really expensive. The S&P 500 trades for 27 times cyclically-adjusted (i.e. 10-year) earnings. That puts it fully 62.7% higher than its long-term average and implies returns over the next eight years of just 0.4% per year. And that’s the nominal expected return, as in not adjusted for inflation. So yes, while these are positive returns, they’re certainly nothing to get excited about.

You know the caveat: past performance is no guarantee of future results. My criticism of the dated Barron’s data could be equally applied to the CAPE data I used above. And I should also point out that I’m not a congenital bear. I’m actually still very heavily invested in stocks, although my focus has shifted to cheaper overseas markets and to higher-yielding investments here, such as mortgage REITs and business development companies.


Where to Look for Cheap Stocks in 2015: CAPE Around the World
3 Under-the-Radar Value Stocks
2015 Investment Outlook

Charles Lewis Sizemore, CFA, is chief investment officer of the investment firm Sizemore Capital Management and the author of the Sizemore Insights blog.

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3 Under-the-Radar Value Stocks

It’s hard to find good value stocks in today’s market. After years of almost uninterrupted bull market, valuations are looking stretched. The S&P 500 trades at 27 times cyclically-adjusted earnings, making them 63.9% higher than their long-term average and implying annual returns over the next eight years of just 0.3%.

To give you a point of reference, U.S. stocks are more expensive today than they were in 2007 and nearly as expensive as they were in 1929—right before two of the biggest bear markets in history.

In order for stocks to grow into their valuations, we’d need to see a massive acceleration of earnings growth. But given that today’s earnings numbers are already inflated by years of massive share repurchases, I can’t say I consider that scenario likely.

Yet value investors need not despair. Here are three solid under-radar value stocks that I expect to do well even in a world of overpriced stocks.

Madison Square Garden

I’ll start with the Madison Square Garden Company (MSG), the owner of the New York Knicks basketball and New York Rangers hockey franchises. This is a relative value play; sports franchises in general are very much in a bubble. But MSG is vastly underpriced relative to its peers, and I intend to profit as its value “catches up.”

The values of premier sports franchises continue to explode, regardless of sport.  The New York Yankees and LA Dodgers are estimated by Forbes to be worth $2.5 billion and $2 billion, respectively, and this despite the declining popularity of baseball and its aging viewership.  In football, my hometown Dallas Cowboys are estimated to be worth $3.2 billion, though I can’t imagine Jerry Jones ever selling. The New England Patriots are worth $2.6 billion, and the Washington Redskins are worth $2.4 billion.  And these values are for a sport with only 16 regular season games.

I broke out MSG’s biggest identifiable assets and businesses and gave my best estimate of their current value. The New York Knicks franchise is probably worth something in the ballpark of $2 billion to $3 billion based on the recent sales price of the LA Clippers (Forbes puts the value at $1.4 billion, but this estimate was made before the Clippers sale).

The New York Rangers are estimated to be worth $1.1 billion, and the value of the Madison Square Garden arena is worth at least the $1 billion recently spent on its renovation. These assets alone put MSG’s value at $4.5 billion – $5.5 billion—or close to its current $5.75 billion market cap. At current prices, you’re essentially getting MSG’s other businesses—including its massive and profitable media empire—for free. And using industry comps, MSG’s media business is worth close to $2 billion.

Taken together, MSG’s major assets and businesses total $6.5 billion – $7.5 billion. Based on this very conservative estimate, MSG is worth anywhere from 13% to 30% more than its current market price. And let me stress, these are conservative estimates. It could easily be worth significantly more.

International Paper

Next up is paper and packaging company International Paper (IP). In an age of green awareness, there aren’t too many more politically incorrect stocks to own than a paper company. But like it or not, packaging is an important part of the modern economy, particular in the age of internet commerce and home delivery. And paper is a lot greener than some of the alternatives, like Styrofoam.

International Paper trades for just 13 times expected 2015 earnings and 0.77 times sales. That’s not half bad in today’s market. But International Paper also pays a respectable 2.7% dividend and has been aggressively raising its dividend since 2010 (International Paper briefly cut its dividend by 90% during the 2008-2009 meltdown). International Paper has grown its dividend at a 46.2% clip over the past three years. That pace of growth isn’t sustainable over the long term, but I still expect solid double-digit dividend growth for a long time to come.

But there is one major catalyst that could cause International Paper to soar by 50%-100% within the next 12 months: conversion to an MLP. Management has openly considered the idea, and tax experts expect any such planned conversion to be approved by the IRS.

Converting to an MLP structure would allow International Paper to avoid paying federal income tax, would free up plenty of cash flow for tax-advantaged cash distributions and share repurchases.

I would never recommend a stock purely because it might reorganize itself as an MLP. That’s lazy research and not likely to generate viable returns over time. But in International Paper’s case, the stock is an attractive, dividend-paying value stock assuming no change of status. Any benefit from an MLP conversion would be icing on the cake.

Lar España

And finally, I’ll leave you with one value stock completely off the radar of most investors: Spanish REIT Lar España (Madrid: LRE).

After raising about €400 million in its IPO last year, Lar has invested about €318 million of the proceeds thus far in a collection of high-quality Spanish real estate assets. As Spain’s economy has modestly recovered over the past year, it’s reasonable to assume that Lar’s assets are worth at least as much as what it paid, meaning that at a bare minimum Lar should be trading at its IPO price of €10. Yet shares currently trade hands at just €9.18.

It’s hard to complain about buying $1 worth of assets for 92 cents. But that is exactly the situation we have today in Lar.

Buying shares of Lar can be tricky and expensive for American investors, so make sure you chat with your broker before placing an order. In my experience, I’ve found that Interactive Brokers charges very reasonable commissions for trades in the Spanish market, and in the interest of full disclosure, this is the broker I use both personally and in client accounts to buy shares.

Disclosures: Long MSG, IP, LRE

Charles Lewis Sizemore, CFA, is chief investment officer of the investment firm Sizemore Capital Management and the author of the Sizemore Insights blog.

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2015 Investment Outlook

I gave a presentation to the Robertson Wealth Management team this week outlining my investment outlook for 2015, and I’m posting the presentation here. I don’t have a complete transcript prepared, but most of the charts are pretty self-explanatory. Enjoy!

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This material is provided for informational purposes only, as of the date hereof, and is subject to change without notice. This material may not be suitable for all investors and is not intended to be an offer, or the solicitation of any offer, to buy or sell any securities.