How does an investment manager reconcile all of the various prognostications he hears on a daily basis?

Simple—ignore them.

—Meb Faber, Global Value

If you’ve never heard of Cambria Investment Management’s Meb Faber, then you have some serious catching up to do.  I consider Faber one of the most innovative strategists in the business today, and I found his research on shareholder yield to be compelling enough to make the Cambria Shareholder Yield ETF (SYLD) a core, long-term holding in multiple ETF portfolios I manage.  (For readers unfamiliar with the term, “shareholder yield” is a holistic measure of shareholder friendliness that includes dividends paid, shares repurchased, and debt repaid.)

Faber’s latest book, Global Value: How to Spot Bubbles, Avoid Market Crashes, and Earn Big Returns in the Stock Market, provides the research underpinnings for Cambria’s latest ETF offering, the Cambria Global Value ETF (GVAL).

Faber is a “quant” who ignores the news of the day and instead focuses on the raw numbers.  At its core, Global Value is a roadmap for implementing the value investing concepts originally espoused by Benjamin Graham and David Dodd in their 1934 classic Security Analysis in a systematic, quantitative manner.

Specifically, Faber uses the cyclically-adjusted price/earnings ratio (“CAPE”), a metric popularized by Yale economist Robert Shiller, as a valuation tool to rank countries.  In Faber’s model, an investor buys the stocks of the cheapest countries as ranked by the CAPE.

The CAPE divides the current market price by the average of annual earnings across the economic cycle, with 10 years being the most popular time interval.

Why?  Because using a single year’s earnings can massively skew the results based on where you are in the economic cycle.  As an example, a collapse in earnings in 2008-2009 would have made the S&P 500 look expensive had you used a simple P/E calculation with 2008 earnings numbers, even though the market had lost half of its value during the crisis.

Faber notes that the U.S. market is expensive today and priced to deliver lackluster returns in the decade ahead.  This is consistent with the forecasts made by, among others, GMO’s Jeremy Grantham.  But Faber—also like Grantham—makes it clear that we are not technically in a bubble.  “Overpriced” does not mean “bubble.”  The former implies disappointing returns; the latter implies the potential for a devastating crash.  And some of the market’s overpricing is a natural product of the low-inflation / low-interest-rate environment today.

But while the American equity markets are looking pricey these days, there are plenty of values to be found overseas for investors with strong stomachs.  Among the countries Faber notes as being cheap—and which, not coincidentally, are current holdings of GVAL—are problem countries Russia, Greece, and Spain.

Do Faber’s methods work?  Indeed, it appears they do.  Variations of Faber’s CAPE strategy returned between 15.9% and 17.6% per year, compounded annually, from 1980 to 2013.The MSCI EAFA Index—the standard benchmark for international investing—returned only 9.6%.  (These numbers exclude taxes, trading costs, and management fees.)

Importantly, Faber’s valuation models are intended, in his words, to be long-term strategic guides, not short-term timing tools.  And had you implemented the strategy espoused in Global Value in 2013, you would have been out of the U.S. market—and would have missed the 33% total returns for the year.  Of course, you would have been invested Greece (GREK), Ireland (EIRL) and Argentina (ARGT), which saw returns of 24.9%, 45.6% and 15.0%, respectively.  That’s not too shabby.

I’ll leave you with a quick summary of Faber’s advice to improve your risk-adjusted portfolio returns:

  1. At a minimum, allocate your portfolio globally reflecting the global market cap weightings. In the U.S., that means allocating 50% of your portfolio abroad.
  2. To avoid market cap concentration risk, consider allocating along the weightings of global GDP. This would mean closer to 60-80% in foreign stocks.
  3. Similarly, ponder a value approach to your equity allocation.  Consider over-weighting the cheapest countries and avoiding the most expensive ones.  Currently, this would mean a low, or zero, allocation to U.S. stocks.

I recommend you pick up a copy of Faber’s Global Value.  And for that matter, I would recommend his Shareholder Yield and Ivy Portfolio as well.  All are excellent additions to any investor’s library.

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.