Where in the World Should You Invest?
Aug 4th, 2006 | By Penny Sleuth Contributor | Category: Commodities, International, MacroeconomicsI was sitting across the table from EXIM Bank executives at a dinner in Washington, D.C. a few days ago. The expansive marble floors of the Washington City Club, its marvelous indoor fountain, wood-paneled dinner room and the five-course French meal provided the perfect setting for investment talk.
EXIM Bank, or Export-Import Bank of the United States, is an export credit agency. That means EXIM helps finance U.S. goods and services to international markets. And that makes the executives at the bank some of the most knowledgeable people when it comes to international trade.
The man sitting next to me was a senior official and an avid investor. I asked him where he sees investment opportunities. He said, “The hot markets like India and China have become too hot. Cooler markets will do better. Just look at global P/E ratios.”
He explained that the “hot” markets tend to have high GDP growth and that’s a bad thing. You read that right — high GDP growth is not necessarily good for the stock market. “You should read the study Triumph of the Optimist by Dimson, Marsh and Staunton,” he said. “They took data from 16 countries since 1900 and found a negative correlation between GDP growth and stock market returns. Can you believe that?”
“Japan had very high GDP growth as you know, but its stock returns were poor,” he explained as he cut into his steak. “Take South Africa. It has low GDP growth but was among the top performing stock markets.”
Why did the high GDP countries have poor stock performance? And what does this mean for investors? The answer lies in P/E ratios. Take a look at this map below:
Countries in green have a P/E ratio between 5 and 10. These include Mexico, Brazil, Russia and South Africa.
Countries in blue have a P/E ratio between 10 and 15. These include Sweden, Italy, France, Spain, the Netherlands and Singapore.
Countries in pink have a P/E ratio between 15 and 20. These include Canada, the U.S.A., the U.K., India and Australia.
Countries in maroon have a P/E ratio of over 20. These include China and Japan.
The data on P/Es was taken from this article.
Notice how all the high GDP countries (like the U.S., China and India) are all either maroon or pink on the map. That means they have high P/E ratios. And that makes sense. High growth always comes with high investor expectations. And high expectations drive the P/E ratio up.
When prices run up in relation to earnings because investors have high expectations of stocks in high GDP countries, the stocks eventually run out of steam.
It is also worth noting that most of Western Europe has a reasonable P/E of 10 to 15. But what’s most interesting are the green parts of the map. Mexico, Brazil, Russia and South Africa all have P/E ratios below 10. And these aren’t high GDP countries.
That means investor expectations are low in the green countries. When you buy stocks here, you’re buying value, not hype. Take Brazil for example. The country had negative GDP growth and high inflation in the 1990s. Yet $1,000 invested in Brazil in 1992 would be worth over $5,000 today. In the ‘90,s P/E ratios were in the single digits in Brazil. Great companies were thrown in the bargain bin. An intelligent investor would have jumped right in.
Take a look at that map again. What makes Mexico, Brazil, Russia and South Africa have low P/Es other than the fact that they have low GDP growth and therefore not hyped? What is common to these countries?
They have all had recent and significant political turmoil (elections, regime changes, etc). Could there be a “political discount” to the stocks in these countries?
I also think the fact that these four countries’ extraordinarily low P/Es have something to do with the commodities boom. The above four countries are home to some of the largest commodity stocks in world, and commodity stocks typically have low P/Es. That means as long as commodity prices rise and earnings are high, P/Es will stay low in these countries.
Does all this mean you should shun high GDP countries and those on the map that are pink or maroon? Absolutely not. But what this means is that you need to be a lot more selective when it comes to investing in the pink and maroon countries, because you don’t want to overpay for their growth.
In fact, at The Global Profit Hunter, we have two carefully selected Chinese stocks in our portfolio. But we also have two stocks that are poised to take advantage of the low valuations — one is a Mexican stock and the other is South African. To find out more, click here.
Regards,
Sala Kannan
August 04, 2006
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