Not Everything Is Expensive If You Know Where to Look
Investors love to complain that asset prices are too high, but they have only themselves to blame.
Investors bid up the S&P 500’s price-to-earnings ratio to 26.8 at the end of 2017 from 11.1 when the 2008 financial crisis eased in February 2009, based on 10-year trailing average positive earnings from continuing operations.
They drove down yields on the Bloomberg Barclays US Corporate High Yield Bond Index to 5.6 percent at the end of 2017 from 16.1 percent in July 2009. They squashed the yield on the Bloomberg Barclays US Corporate Bond Index to just 2.7 percent from 7.2 percent in May 2009. And they did the same to real estate. The FTSE Nareit U.S. All REITs Index yielded 4.1 percent as of November, down from 11.1 percent in February 2009.
Private equity looks stretched, too. According to PitchBook, the median enterprise value-to-Ebitda ratio for buyout deals averaged 6.3 from 2012 to 2016, the earliest year for which numbers are available. That multiple jumped to 7.5 as of February 2017, the most recent number available.
Common threads run through all those assets. The first is that U.S. investors like to stay home. According to Broadridge, which tracks data from 80,000 funds globally, 70 percent of the assets in U.S. equity mutual funds and ETFs are invested in U.S. stocks despite the fact that they account for just 52 percent of global market cap. Investors like overseas bonds even less. Roughly 87 percent of assets in U.S. bond funds are in U.S. bonds, even though they represent just 38 percent of global bonds.
The second is that U.S. assets look great in the rear-view mirror. The S&P 500 returned 18.2 percent annually from March 2009 through December, including dividends. The All REITs Index returned 17.1 percent from February 2009 through November. And the Cambridge Associates US Private Equity Index returned 14.7 percent from the second quarter of 2009 through the first quarter of 2017.
Even boring bonds have been great. The Bloomberg Barclays high-yield index returned 10 percent annually from July 2009 through December. The corporate index returned 5.8 percent since May 2009.
That combination of home and recency bias is blinding. But investors who can overlook them will find more reasonably priced assets elsewhere. For example, the MSCI World ex USA Index -- a collection of companies in 22 developed countries outside the U.S. -- trades at a P/E ratio of 17.9, a third cheaper than U.S. stocks. And the MSCI Emerging Markets Index trades at a P/E ratio of 14.6, nearly 50 percent cheaper than the U.S.
Prices are even lower among beaten-down overseas companies. The MSCI World ex USA Value Index trades at a P/E ratio of 14, and the MSCI Emerging Markets Value Index trades at a P/E ratio of just 10.7.
Despite cheaper prices overseas, it won’t be easy for U.S. investors to leave the comforts of home. For one thing, investors often conflate familiarity with safety. They also tend to overstate the U.S.’s prowess, despite the fact that the U.S. ranks poorly in areas that have a meaningful impact on the economy over time, such as health and education.
It’s also hard to overlook the poor performance of overseas markets in recent years. The S&P 500 returned 8.5 percent annually over the last 10 years through December, while the World ex USA Index and the Emerging Markets Index have returned just 2.4 percent and 2 percent, respectively. Value stocks fared even worse overseas.
Investors can keep hugging U.S. assets, of course. But when they complain that “nothing is cheap,” what they really mean is “nothing I like is cheap.” That's a big difference.
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