Bubble or not ?
There has been a lot of discussion about the level of the US stock market and warnings that it is approaching (or already is) in bubble territory. The CAPE of S&P 500 is 26.31, way above historical mean (16.55) and median (15.93) values. But is it in QE induced bubble values? There are some segments, where valuation does seem to be very high. Small cap valuations are streched. Social media and biotech also seem very expensive, though I have to admit that those are areas that I do not have any experience. But I do not think that the whole market is in a bubble. Current P/E is 19.16 and P/B is 2.8 which are high, but not really out of this world high. Also the equity risk premium is still above historical values being 5.38 % vs. the historical average 4.20 %. This gives even room for a rate increase, which will come sooner or later. But one should not expect very high increases from the FED, because inflation is still quite low. The equity risk premium will probably reach is historical norm, but a sudden collapse would seem unlikely. So in summary US market most likely is not in a bubble, but it certainly is not cheap either. So why not look into more reasonably priced parts of the world? Bubble or not, I think better returns can be achieved elsewhere.
Europe & Emerging markets
Is Europe then the place to be? At least based on CAPE and compared to US it is. Europe has much lower CAPEs across the board. Italy for example seem especially cheap with CAPE of 13.4. Some other cheap countries are Greece, Austria, Finland & Holland. Also P/B ratios seem to confirm the story values being well under the US figure of 2.8. Current P/E:s are high though, probably because the earnings are from (or at least near) the cycle bottom. From the bigger European markets also UK & Spain seem cheap having CAPEs of 15.8 & 14.08. France & Germany are also a lot cheaper than US based on CAPE.
Emerging markets also have much lower valuations. For example China's cape is 10.8 and Brazil's is 13.7.
It might be wise to underweight US stocks and the biggest returns there are probably already achieved. S&P 500 rose 30% in 2013 and YTD return now is also about 8.5%. Inflation has been very modest and under 2%, so real returns have been quite phenomenal. More gradual figures are to be expected.
Europe and Emerging markets still remain attractive. Europe would be the more conservative bet, since many of the Emerging markets has suffered from currency fluctuations and could suffer short term depending on FEDs actions, since rising rates could result as a large capital outflows from emerging economies. Europe is of course also quite depressed now, but interest rates are also very low, so equities are attractive despite the poor growth prospects. I would not be surprised if some money from US stocks would be flowing to Europe in short to medium time frame. Also the larger European companies are really multinationals and no so dependent from European markets.
Countries like Italy, Spain, UK & France could also be fertile ground to stock pickers. Even though most of these countries have mainly been in the headlines because of the negative prospects, these are still developed and large economies, which have a lot of great innovative international companies. (Some examples : Total S.A. (NYSE:TOT), Banco Santander S.A. (NYSE:SAN), Telefonica (NYSE:TEF), Luxottica (NYSE:LUX), Telecom Italia (NYSE:TI) etc.) Also for a more enthusiastic digger the smaller companies in these countries could have some very potential risk/reward -profiles if the Euro area were to achieve solid growth in the future.
Emerging markets should not be forgotten ether but I think that the best way to invest would probably be through an low cost index fund, since direct stock purchases are more difficult and liquidity could be a risk there in addition to possible currency fluctuations. Russia should not be forgotten either, since it is also a very cheap at the moment. (Actually the cheapest: CAPE=7.69, P/B=0.7) For a risk taker some individual Russian stocks like Sberbank (OTCPK:SBRCY)(P/E 4.84, P/B 0.88) could offer great potential returns. Of course the political risk should be considered.
Some product ideas
One of the simplest ways do diversify away from US would simply be some world ex. US index. For example Vanguard FTSE all world ex. US (NYSEARCA:VEU) seems to be quite a good candidate. It has a low 0.15 % expense ratio and one would get cheap and wide exposure to Europe, Japan, Asia and Emerging markets. A contrarian or value minded person could further concentrate to cheapest markets with Cambria Global Value (NYSEARCA:GVAL), which invests to cheapest stocks in the cheapest markets measured with CAPE. (expense ratio 0.69%) Also SPDR offers quite interesting new smart beta -products, which try to capture low volatility, value and quality factors. SPDR MSCI Eafe (NYSEARCA:QEFA) invests in EAFE (Europe, Australasia, Far East) countries. 5 largest countries are UK, Japan, Switzerland, France & Germany. The index is constructed as a 1/3 mix from MSCI corresponding strategy (value, quality, low vol) indices. So one should get quite good factor exposure with actually quite low costs. (gross expense 0.30%) Coupled with SPDR MSCI emerging markets Quality Mix (NYSEARCA:QEMM) one would gain exposure to emerging markets too, so this would be a good mix for someone looking for cheap factor exposure outside US markets. (I am personally quite interested)
In summary I think that shifting exposure outside US could be a good bet at the moment, bubble or not.
Disclosure: The author is long GVAL.
The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: The European CAPES & P/B:s not real time. Figures are early June 2014.