For many investors, it is considered much safer to stay on the sidelines during any kind of global crisis. Yet, during relatively calm times, the valuations of many stock markets are quite high, which can also result in scaring investors away from investing. Personally, I have tended to get more worried when the world (and the prices) are relatively rosy. However, during crises, some investors, including myself, have frequently found opportunities to build up long-term positions in select stock markets that have become very reasonable, often even mispriced.
Take South Korea in 1999, during their "International Monetary Fund crisis," or in China in the early 2000s, when the news on China was much more negative than anything you read today. These markets doubled in a matter of years, and although China in particular has undergone volatility, it turned out that buying China a decade ago was not a bad bet. Similarly, in 2009 and 2010, while most of the world still thought of Mexico as a country destroyed by the drugs wars, it became one of the top-performing markets.
This is not to say that all of my bets have been winners. For instance, in Turkey has gone south in the past 12 months and I did not foresee the political climate turning as sharply negative as it has. However, there are several great companies there, and given the present depressed prices, it is not a bad place for long-term investors to have 0.5 percent to 1.0 percent of one's equity portfolio, which isn't a giant bet.
On average, due to the measured bets in South Korea, China, Mexico and recently, selected sectors in Europe, the net returns have been well worth the perceived risks. Of course, American investors were all pleased with being overinvested in the U.S. stock market in 2013. Indeed, the position has grown so large in the last year that I and many others have had to rebalance and decrease our U.S. weighting, just to keep our portfolios in line with our long-term global target weightings. However, investing only in the U.S. means that your may not be fully diversified.
Perhaps these sound like the words of an active trader, but quite the opposite is true. I simply believe in the slow accumulation of a broad-based global portfolio over a long period of time. It can be advantageous to accumulate in underweight categories when the prices are especially low by a variety of standard comparison metrics. When certain countries are hammered, and most of the press and analysts are down on a particular market, it may be time to at least consider some of these markets. Of course, after looking at all these factors, you may say to yourself, "Yes, the prices are depressed because they should be."
Still, when you see that the relative metrics are so low that it looks like all the bad news is priced into the market already, and none of the possible good news, it may not be a bad time to begin to accumulate or add to a long-term position in this category. In a 2005 speech on China, I said to primarily Chinese and Japanese reporters, "Look at the quality of several of China's companies relative to their foreign counterparts. The only thing wrong with them is their headquarters' address." This is an example of a possible buy signal.
So, once you see something that most everyone hates, for instance, a particular country's market, what are the kinds of metrics you can look at, either alone or with your advisor?
Relative price-earnings ratios of stock markets. The quick and dirty way to check is to look at how much less is everyone willing to pay for this depressed market vs. other countries that are considered appealing. For instance, the U.S. is selling at a 40 percent plus premium in forward P/E vs. South Korea, China, Colombia and Peru. P/E can be quite misleading, especially at times when earnings are quite low, but at least it is a signal to look further at other metrics.
Comparison of industry sector valuations across countries. One metric I love to see is one or two companies competing in the exact same sector as companies in other countries, and they are selling at a much lower P/E. That means things are getting interesting.
P/E comparisons relative to growth projections. An even more enticing situation is when the lower-priced country not only has undervalued stocks in easy-to-compare sectors, but the depressed country's firms are growing faster than in the higher P/E countries. In other words, investors are not even paying for the depressed country's economic growth. For instance, the current Standard & Poor's 500 index P/E is at a 40 percent premium over China, yet China's growth rate will be more than double of the U.S. this year. Yes, China should have a "risk premium" factored into its price, but this quite a spread.
Market-to-book value at a discount. Although there can be a lot of noise with this tough metric, when you see that the world won't pay much of a premium for the country's companies' book value, there may be a real value opportunity. Currently, South Korea (home of Samsung Electronics) sells at a price to book of 1.1, Chile at 1.6, and Poland at 1.8, compared to the U.S., at 2.6 times.
When you see a group of such favorable metrics and there are several well-run, growing companies inside the depressed-stock market country you're evaluating, it is time for you to seriously consider accumulating at least a little money in some of those markets.
Of course, there aren't any guarantees. The prognosis of the political situation in a country, along with its neighboring countries, is probably the most difficult assessment to make. However, even in that scenario, if you sense that the country won't be totally destroyed by the event/situation, or dramatically affected by a particular crisis in the news in the long term, it may be worth considering at least a small accumulation.
Tim McCarthy is the author of "The Safe Investor," released in February 2014, and former chairman and CEO of Nikko Asset Management Co. He has also worked at other large financial institutions such as Fidelity Investments and Merrill Lynch.
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