URTH: Global Stocks Should Keep Rising

Summary

• URTH is a global equity fund that offers investors the ability to invest in a basket of developed markets, not just the United States.
• A simple valuation gauge would suggest that URTH is possibly undervalued; priced at a cost of equity that exceeds the probable fair cost of equity.
• Provided that the global economy does not face runaway inflation, it would seem as though global equities should be able to continue to rise.

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iShares MSCI World ETF (NYSEARCA:URTH) is an exchange-traded fund that enables investors to get exposure to a broad range of developed market companies around the world. While the fund offers international equity exposure, it still follows a market-cap-weighted methodology, and therefore, the United States (being the largest and most popular equity market) earns itself a high allocation. And as global equity markets are largely, positively correlated, URTH basically functions as a more diversified source of "beta". But the lesser reliance on the United States is a nice feature and enables one to perceive the fund rightly as being lower risk than a U.S.-only index fund.

The expense ratio is 0.24%, which is not as cheap as funds from Vanguard (for example) that focus only on the U.S. equity market. But 24 basis points is still quite cheap and a reasonable price to pay for the global diversification. The geographical exposures are as presented below.

(Source: iShares)

The United States represents almost 70% of the fund, while the remainder is spread across Japan, the United Kingdom, Canada, France, and several other European countries.

Using data from Professor Damodaran, including a base mature market equity risk premium of 4.53% for November 2021, I include default spreads and 10-year yields (risk-free rates) for the main country allocations of URTH and weight them according to fund allocation. Using these main allocations, I re-rate upward (to 100%, as these alone do not add up to 100%, owing to other minor allocations and cash holdings) to find a weighted cost of equity.

Morningstar suggests three- to five-year earnings growth rates of 13.99% at present, which is reasonable and conceivable. The forward price/earnings ratio is 19.06x. Data from Fidelity suggests the trailing price/earnings ratio is 20.69x. Using this data together with our cost of equity assumption allows us to build a short-term valuation gauge as follows.

This simple method suggests upside potential of about a third (33.3%). Or in other words, the implied cost of equity is not 6.16%, but more like 8.06%. That seems like a small difference, and I suppose it is if we consider the uncertainty of these measures, uncertainty concerning future earnings growth, and uncertainty concerning the whims of investors and investor sentiment (which directly affect equity risk premiums, including country risk premiums). Inflation uncertainty will also affect bond (risk-free rate) volatility going forward. But, ultimately, I think my approach reasonably illustrates that equity markets are not in a bubble globally.

Corrections are common and to be expected, but a significant correction (say, over 10%) would likely require a significant, adverse change to forward earnings globally. Supply chain risks and logistical challenges, as well as elevated food and energy prices (in part owing to those former challenges) are driving some uncertainty at present. But, arguably, these will be transitory (markets are competitive and largely efficient), and so in the long run, I think markets will continue to rise against these "solvable problems".

We might see some natural, short-term downside here and there, but URTH seems to illustrate the global equity markets are largely fairly priced (if not undervalued), and so unless the global economy experiences runaway inflation, valuation risks are probably modest. Recent work from The Economist shows the relevance of food and energy prices and how excessive volatility in just a few segments of the "inflation basket" can drive headline inflation figures. And while the research would suggest that inflation is likely to be higher than expected on a forward basis, inflation is likely to moderate (i.e., come in lower than on a trailing basis).

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.