The second half of 2015 was tough for investors, with global markets falling sharply, prompted by concerns over China's yuan devaluation. But since February many major indices, including the FTSE 100, have rallied and are at (or near) all-time highs. So where should value investors look in search of bargains?
Dividends tell a similar story: China and Russia yield 4.1% and 4.3%, against a global average of 2.6%. Again, the US looks relatively expensive on 2%. But other markets look more attractive on this measure than on earnings. For example, yields for Australia, Spain and Taiwan are not far off China's levels, while the UK also looks comparatively cheap with a solid yield of 3.6%.
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Of course, p/es and dividend yields can be flawed measures of value. P/es can be skewed in markets dominated by cyclical stocks (the heavy weighting towards resource stocks in the UK index is one reason the p/e looks so high). Meanwhile, yields are hard to compare between countries due to differences in the tax treatment of dividends.
A popular alternative metric is the cyclically-adjusted p/e (Cape). Cape measures prices against the average of earnings over the last decade. Originally devised by Benjamin Graham and David Dodd for individual companies, the idea is to give investors a better idea of how cheap a stock currently is compared to average profits over a typical economic cycle. Research by Professor Robert Shiller, now at Yale, found a strong negative correlation between Cape levels and future US stock returns (ie, a higher Cape led to lower returns). Further research by Star Capital confirmed that other major international markets have a similar relationship.
So what does the Cape ratio suggest today? That Russia and eastern Europe are very cheap, on Capes of 5.1 and 7.7 respectively. China, however, is on a Cape of 14 still below the global average, but not quite the bargain-basement level implied by the simple p/e or dividend yield. Indeed, the UK also has a Cape of 14.
The US trades on a Cape of 25.5, expensive by historical levels. Some experts have argued that this suggests the Cape is no longer valid for the US, but Shiller himself notes that while Cape is a useful predictor of long-term returns, it's not a timing device. And just because a market is expensive, that doesn't mean it can't get even more overvalued during the tech bubble, the US Cape rose to more than 40.
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