Portfolio Update: Betting Against The U.S.

Summary

• I believe we are on the cusp of a multi-year reversal in global equity performance, with international, resource, and value stocks set to dramatically outperform U.S. stocks.
• U.S. equity outperformance over recent years has primarily been due to the increase in price investors have been willing to pay for U.S. dividends, which is likely to reverse.
• After turning net short global equities in August, I have shifted back to a net long stance due to increased bets on mining stocks and new positions in Chinese stocks.

benedek/E+ via Getty Images

I believe we are on the cusp of a multi-year reversal in global equity performance, with international, resource, and value stocks set to dramatically outperform U.S. stocks. In early August I shifted to a net short position in my equity portfolio, raising my short positions on U.S. stocks to 60%, with the remaining 40% in international, value, and resource stocks. While I believe U.S. stocks have much further to fall I have shifted back to a slight net long position by increasing my gold mining positions and adding a long position in Hong Kong listed Chinese stocks following recent weakness.

Portfolio Weightings

The following table shows the percentage weighting of various assets on the long and short side of my portfolio, alongside their projected 10-year total return forecasts. The forecasts are based on a number of different valuation metrics and their historical correlation with subsequent returns.

Table Of Long And Short Portfolio Weightings

Longs	% Of Portfolio	10-Year Annual Return Forecast, %	Shorts	% Of Portfolio	10-Year Annual Return Forecast, %
Gold Miners	10	8.2	US Growth	15	-5.0
Oil & Gas	8	6.9	US Large Cap	15	-3.8
UK Large Cap	7	5.5	US Small Cap	15	-3.4
UK Value	7	6.0
EM Value	5	6.0
Silver Miners	5	8.2
Singapore	5	5.9
Hong Kong	4	6.0
Latin America	4	6.0
Total	55	6.7	Total	45	-4.1

Click to enlarge

Source: Author's calculations

I currently expect annual total returns on the long portion of my portfolio to outperform the short side by almost 11% per year over the next 10 years in total return terms. This may sound absurd considering the performance of these markets over the past decade. As the chart below shows, U.S. stocks have outperformed international, value, and resource stocks by a staggering 20% per year for the past five years in total return terms. However, it is this extreme price divergence that strongly suggests future return prospects favor a reversal.

Source: Bloomberg, Author's calculations

The next chart shows the dividend yields of the two indices going back to 2004. The outperformance of U.S. stocks over recent years has primarily been due to the increase in the relative price that investors are willing to pay for U.S. dividends. As a result, the international, value, and resource stock index now yields 4x more than U.S. index, which is double the long-term average. Even if this record valuation divergence remains intact indefinitely, I would expect to see positive returns due to the dividend differential. If the valuation differential returns to its historical average, then double-digit returns are likely.

Source: Bloomberg, Author's calculations

Raising Long Positions In Gold Miners

I have raised my long positions in gold and silver mining stocks following the recent declines as I continue to believe that the long-term precious metals bull market remains ahead of us as it becomes clear that policymakers will not be able to wean themselves off their addiction to printing and spending. Even if gold and silver stocks remain at current depressed levels, mining companies are undervalued on a historical basis and now offer dividend yields in excess of the SPX. This is a rare occurrence and makes mining stocks particularly appealing given the additional benefits of precious metals as a hedge against future stagflation.

Trailing Dividend Yield For Solactive Silver Miners Index, NYSE Arca Gold Mining Index, And SPX

Source: Bloomberg

Adding Long Positions In Chinese Stocks

I have also added a long position in Chinese stocks following the double blow they have received over recent months from rising regulatory risks facing the tech sector and financial sector contagion concerns from Evergrande (EGRNF). Sentiment towards China is at rock bottom and valuations have become too attractive to ignore. The financial sector for instance now trades at a forward price-to-earnings ratio of 4.7x and offers a 6.8% forward dividend yield, highlighting the degree of revulsion towards Chinese financials currently.

Hang Seng China Financials Forward Price/Earnings Ratio

Source: Bloomberg

Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Comments

[n00binvest19]

Will never happen

[Karphe]

Great write up, and I strongly believe so as well.
Comparing US Stocks to other regions, PE ratios and other metrics seems quite elevated.
Russian Index (MOEX) trades at a 9.55 PE (with 4.3% div-yield), Hang-Seng Tech Index trades at 17.5 PE, NIKKEI trades at 16.2 PE compared to >25PE of SPX and Nasdaq. If one has access to those markets, I would consider reallocating.
Which kind of stocks would be included in your category of EM Value or do you play it via ETFs?

[only-temporary]

There's so much fear and anger towards China. It certainly feels like emotions have taken over.