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In the previous two columns I argued myself into ditching US equities on valuation grounds alone. Er, interesting call bro, some of you emailed to say. You’re an absolute muppet, said many more.
All true. Especially as two problems arise: one small but possibly costly, the other existentially worrisome. The former is that I’m obliged to wait 30 days between writing about a change in my portfolio and trading.
Which means I need the S&P 500 to hold up a while longer. It reached its highest level in 15 months this week. US consumer confidence and housing data also were strong. Meanwhile, the Fed said nothing to rattle equities on Wednesday. More of the same, please!
Of greater concern, the logic of which doesn’t require an Oppenheimer-sized brain to grasp, is that if I’m selling the world’s largest stock market because it is grossly overvalued, I should jettison my other shares too.
If I am proved correct on the US, there is zero chance that other equity indices can do anything but crash. Nuttier types might even warn that the collapse this implies is bunker and pickaxe time. Forget portfolio optimisation.
At the very least, even markets with compelling valuations, such as the UK or Japan, would suffer. When US bourses halved in 2008, the Footsie and Nikkei dropped 30 and 40 per cent respectively. It did not matter that the crisis was born in the USA.
Hence the only justification for not selling my other stock ETFs at the same time as my S&P 500 fund, it seems to me, is if I assume that the US declines much less than suggested by the fair values based on Cape and Q — the ratios I focused on.
Sure thing! I’m a positive guy. The S&P 500 always bounces back, even if valuations are gagging to add another bear market to the two dozen since the depression. Besides, who would be around to read this column if they were out forming a militia?
So let us agree that I can still consider owning other equity funds. Phew! Therefore my new base case is that US shares fall, but not by enough that stocks cannot rise elsewhere. How about in Asia ex-Japan, for example?
Looking at the region makes sense, as you often hear that a consistently strong US market precludes investors from buying it and sending prices higher. I heard this excuse a lot when managing global ex-US portfolios.
Shunning Wall Street is positive for Asia in other words. This is nonsense, of course — confusing flows (for every buyer there’s a seller) with fundamentals as usual. But it is definitely harder to promote Asian funds when US shares are booming.
From 2002 to 2012, for example, the S&P 500 returned 6.5 per cent a year on average and $60bn was put into Asian ex-Japan funds, according to Refinitiv data. For the past decade US equities rose at twice the pace and $25bn came out.
If the S&P 500 does wobble, asset managers will race to flog Asian stocks to overseas investors. And of all the flim-flam when promoting their superiority, having a “big local presence” is the most common.
You would think being near the action helps returns. Kicking company tyres and interrogating chief executives on the golf course. Hundreds of analysts on the floor. News before the rest of the world wakes up.
But academics are united. It matters not a jot. You are just as likely to outperform or underperform when running US equities from Frankfurt or emerging market debt funds in Sydney. In fact sometimes it is positively disadvantageous being local.
Why do I raise this? Because in my 30 years in the business, Asia is where I have seen this problem the most. Not so much in the selection of individual shares, but rather that living in the region seems to turn everyone bullish.
Something in the rice? Or maybe it is the buzz that accompanies growth rates long forgotten in the west. It may well be “Asia’s century” but what counts are returns on equity. Blind flag waving is accentuated by perennially inferior returns versus developed equity indices.
Asia is always next year. In the latest research reports, analysts are apologetic for recent performance but remain upbeat. They have been thus as long as I can remember.
Likewise, the reasons given to buy are as old and hackneyed as me. Asia has lots of people. Rising middle classes. Attractive ratios — versus the US, versus output, you name it. Global uncoupling. Internet penetration. A new focus on cash flows. Yadda.
And yet my MSCI Asia ETF is down another 2 per cent this year and trails its equivalent MSCI world fund by 50 per cent over the past decade. There are Lambos and Rolexes galore in Asia — but no thanks to the stock market.
Surely the laws of probability say Asia is due? As I’ve written before, relative valuations do exhibit mean-reverting characteristics in the long run. Compared with the S&P 500, for example, Asia-ex Japan shares haven’t been this cheap on a price-to-book basis since the dotcom bubble, after which they left the US for dust.
But cheap compared with something bloody expensive (see last week) isn’t a great advertising line. Plus outperforming doesn’t necessarily mean rising in absolute terms. I need more reasons to believe Asia ex-Japan can make me some money.
There are possibly two. A weaker dollar would help. In a Bank of International Settlements working paper last year, economists Valentina Bruno, Ilhyock Shim and Hyun Song Shin show that not only are translated returns amplified, but appreciating domestic currencies boost local equity markets.
It’s worth a punt. So is betting on a resurgence in stocks — which still account for a third of the benchmark — after a horrible year and a half. In conclusion, my gut wants me to keep with Asia ex-Japan for now. History says I’ll be sorry for the umpteenth time.