Valuation Is What Matters

The only consistent determinant of long term returns has been valuation. The economy was great in the late nineties but it was a terrible time to invest because valuations were so high. By the same token the 1970's and The Great Depression were terrible economic times but great times to buy stocks.

The German DAX is trading at ten times earnings and a greater than 4% dividend yield. In the long run this is likely to be a great investment. Stocks don't trade at these types of valuations during good times. I am researching ways to invest in Germany. The only liquid large cap ETF I can find is EWG, which represents the MSCI Germany Index but is not very well diversified. If any readers know of anything better please let me know.


daan ridder everts said...

GF is a closed end fund for Germany. It is trading below NAV and is more diversified than EWG. No options on it though and average volume is 50k.

frank r said...

First, a PE of 10 is not that unusual these days. Intel and Microsoft both trade below 10 on a ttm basis. And why limit yourself to Germany? The whole of Europe is cheap on a PE basis. I buy Vanguard ETFs. VGK, which is their European ETF, has a PE of 11.9 and 1.5 book value. The expense ratio is why I prefer Vanguard: .14%, because I would ultimately like to buy and hold, but that requires that stock prices come down and stay down instead of being constantly driven up by momentum speculators. If youa re short-term trading, then expense ratios are less important than liquidity. The two Vanguard ETFS I use, VTI and VEU, both have low expense ratios and good liquidity.

The Japanese market is also cheap and has been cheap for a while, both on a PE and book value bases. But that brings up the big question of whether the reason stocks are cheap, based on ttm PE's, is because the market is anticipating that the whole world is going the route of Japan. That is, a decade of stagnation. This will be bad for the E part of the PE ratio, so maybe those PEs aren't as great as they look. Note that Germany is the country in Europe which most resembles Japan: big trade surplus in manufactured goods, aging population, highly disciplined culture which does not like the disorder associated with high inflation.

The other thing to consider is what exactly is your circle of competence. From reading this blog for a while, you appear to have a good feel for short-term sentiment. If you work full-time exploiting that speciality, you should be well-compensated for it. After all, you are bringing valuabl information to the marketplace  by buying when sentiment is low and selling when it is high, and those who bring good (as opposed to wrong or noisy) information to the marketplace should be rewarded for doing so, assuming the markets work as designed. So if you are buying the DAX because you noticed that the market seems to be overreacting, sentiment-wise, specifically to DAX as opposed to the other European markets, then you might make money. Otherwise, there are plenty of hedge funds and active managers with a mandate to seek out cheap European stocks. So if German stocks really are cheap, they will surely have moved in by now. And not by buying an ETF tracking DAX either, but by buying the very best values within DAX.

My own circle of competence is much longer range market timing. Like you, I am intensely interested in sentiment. Specifically, I am looking for final capitulation of the bear market that began in 2000. March 2009 does not count as final capitulation because the rebound was so swift, though I did go all in then, and then later sold everything because of the rapid rebound. The rebound from true capitulation will be much slower. Prices in march 2009 were good and they are  okay now, based on historical PEs. But it is possible that the market is structurally different. More people buy stocks now than in the past, so maybe the average PE in the future will be closer to 20 than 14. I'm open to this possibility, which is why I use sentiment in conjunction with valuation. If the sentiment says we've reached final capitulation but the PE at that time is only 15 let's say (based on trailing 10 years earnings, according to Shiller's method) rather than single digits, then I'm ready to go all in again. But I don't see that final capitulation sentiment nor do I see great valuations on a PE10 basis. Which is why I have only moved 20% to stocks so far. The market will probably climb a wall of worry for a while. If it climbs enough,I'll sell that 20% because I'm convinced I'll get a better price eventually.


Long The DAX said...

[...] long the German DAX via a European traded ETF, with the symbol  EXS1. I explained my reasoning in a previous post. Tsachy Mishal on September 8, 2011 at 8:56 am | Filed Under Uncategorized [...]

Tsachy Mishal said...

I own a core portfolio of value positions and use sentiment to trade around those positions and/or hedge them. There is just a lot less to say about a value stock so I might lay out my case once and update it every few months. There might be a post a week if I only wrote about value stocks. Most of the posts on the site tend to be about shorter term stuff simply because there is much more to write. I have not done a study but I believe more of my returns come from stock selection than market timing.

The US has stocks at ten times but the overall index trades over 12 times. I like Germany because the valuation is cheap, there is not a credit bubble there and the fiscal situation is excellent. Im not saying other countries cant turn out better if the valuations are lower, but I prefer the less hairy situation.