Why U.S. Equities Look Expensive, But Japan Does Not

Includes: EWJ, HDV, IOO, OEF
by: Russ Koesterich, CFA

Call No. 1: Lower To Neutral On U.S. Equities

I’m downgrading my view of U.S. equities to neutral from overweight. Since I first initiated an overweight on U.S. stocks last December, large-cap U.S. equities have outperformed global equities by roughly 5%.

The United States has recently become marginally more expensive relative to other countries at the same time that its growth prospects have worsened by slightly more than average. While I’m lowering my view of U.S. equities, I’m maintaining my long-term overweight view of global equities and global mega caps (potential solutions: OEF, IOO and HDV).

Call #2: Upgrade To Overweight On Japanese Stocks

I’m upgrading my view of Japanese stocks to overweight from neutral given Japan’s low valuations, better growth prospects and stable risk.

This is primarily a value call. Japan currently trades at under book value, down from 1.11 times book value six months ago. Japanese equities are also trading at a particularly good value currently relative to their own five-year history, during which the Japanese market’s average price-to-book ratio was 1.35.

Though this could seem strange to some, Japan may actually turn out to be a growth story in 2012, at least compared to Europe and the United States. Japan’s leading indicators have actually held up OK on a relative basis, and Japan’s consumer confidence has been increasing since April lows.

Finally, despite Japan’s high government indebtedness, credit default swap spread levels suggest that the market doesn’t perceive Japan as a risky sovereign. This is likely because a lot of Japan’s debt is held domestically. And Japan also has a current account surplus (possible iShares solution: EWJ).

Disclosure: Author is long IOO and EWJ.

Source: Bloomberg.

Original post

Disclaimer: International investments may involve risk of capital loss from unfavorable fluctuation in currency values, from differences in generally accepted accounting principles or from economic or political instability in other nations. Securities focusing on a single country may be subject to higher volatility.