The best stocks may be outside the U.S. market if you are looking at long-term earnings. A number of broad indices including the ones in Brazil, Russia and much of Europe is undervalued at the moment and could give you high returns in the long-term. Markets in Europe were extremely expensive in the last few years and many are looking at this window as a buying opportunity. However, a number of irritants remain in the global economy and volatility has become a constant factor.
Why should you go for markets with low CAPE ratio?
The CAPE ratio or cyclically adjusted price by earning ratio also called P/E 10 ratio or the Shiller P/E ratio is a valuation metric and is used to estimate the real per share earnings over the last 10 years. It is a very important metric because the value being adjusted for inflation makes it free from volatilities and price fluctuations. A stock’s price is divided by the average of 10 years of actual earnings from the equity or broad index.
The CAPE ratio looks most attractive for Russia at 5.1. Brazil’s CAPE ratio at 9.6 makes it equally attractive. The emerging markets had almost been written off after the January-February slide this year but look very attractive once again. Most investors are ready to go on a limb if higher returns are guaranteed. The U.S. markets have a CAPE ratio of 25.6 and seem to be overvalued at the moment.
The trick lies in diversifying your portfolio by quality stocks from different markets around the world that have strong fundamentals and have given a good yield over the last few years. Buying a basket of stocks from 10 undervalued countries would mitigate the risk to a large extent even at the face of volatility because these stocks are valued as almost half of the most expensive basket of stocks. The downside risks are much lower than markets where the valuations are high.
Although emerging markets and parts of Europe are looking really attractive right now, you should exercise caution before investing. Study the stocks or indices carefully because the volatility is extremely high in emerging markets due to low market capitalizations and overdependence on foreign inflow of money. Also, every time the U.S. Fed tightens its fiscal policy and increases the interest rate, money will be whisked out from the emerging markets and get parked in more stable and safer U.S. markets.
Know what you are doing. Don’t go with the flow just because somebody is asking you to go with the trend or against the trend. However, it can be asserted with some degree of certitude that undervalued markets will offer more attractive returns if one can look past volatility.