Having followed the stock markets after the 2008 crisis, I want to give a performance update for the Dow Jones vs. the Shanghai Stock Exchange vs. Europe. The Dow Jones has gone up 50% after the 2008 stock market plunge (Chart 1), while the Shanghai Stock Exchange has gone up first, but essentially lost all of its gains in the period between 2010 and 2012 (Chart 2). The European stock market (NYSEARCA:VGK) has gone up 13% since the crisis of 2008.
Indeed, many economists have pointed out that the U.S. stock market (NYSEARCA:DIA) has outperformed almost every market in the world, especially Europe. Marc Faber pointed this out in a recent interview on Bloomberg Radio. I believe it's time to reverse our positions.
Let's first compare the Dow Jones against the Shanghai Stock Exchange. One went up, the other went down, respectively. How can there be such disparity? It can't be the exchange rate between the USD and the CNY, because the Chinese yuan has only gone up 5% against the USD between 2008 and 2012. The obvious reason is a slowdown in the Chinese economy, which can be seen in the declining Chinese PMI and the decrease in Chinese electricity consumption. I believe the Shanghai Composite index has already discounted this slowdown. Let's look at the valuations.
I'll analyze the basic market metrics: P/E, dividends, book value.
1) P/E ratio
The P/E ratio of the Dow Jones is at 14.5 today. The 10 cheapest stocks in the Dow Jones have a P/E ratio of 11.6. The stocks with a high P/E ratio include Johnson & Johnson (NYSE:JNJ) with a P/E ratio of 21.87, Procter & Gamble (NYSE:PG) with a P/E ratio of 20.11 and General Electric (NYSE:GE) with a P/E ratio of 16.56. Historically, a P/E of 14.5 is above average and I expect the stock market to decline to a P/E ratio of around 10.
If we compare the P/E ratio of the Dow Jones to the P/E ratio of the Shanghai Stock Exchange, we see a small difference. The average P/E ratio of the Shanghai Stock Exchange is 11.5. This essentially means that it's cheaper to buy stocks on the Shanghai Stock Exchange than on the Dow Jones. On the other hand, if we look at the Shenzhen stock market, we see an average P/E ratio of 22. Some examples: Petrochina (NYSE:PTR) trades at a P/E of 10.8. Ping An Insurance trades at a P/E of 17. China Pacific Insurance (OTCPK:CHPXY) trades at a P/E of 20. As Marc Faber pointed out on Bloomberg, the good Chinese companies aren't particularly inexpensive. So I wouldn't advise investors to buy in just yet.
2) Dividend yield
Second, let's analyze the dividend yields. The average dividend yield on the Dow Jones is around 3%. If we take the 10 cheapest stocks we get a dividend yield of 3.63%. One of the best performers is AT&T (NYSE:T) with a dividend yield of 4.7% coming from a dividend of 10% a few years ago. These high dividend stocks are a good place of refuge during a crisis. One word of caution though, the valuations of these income stocks are historically high as compared to the broad market as shown in Chart 3.
|Chart 3: Relative trailing P/E of large-cap stocks with highest quintile of dividend payout ratios to the market|
On the other front, the average dividend yield on the Shanghai Stock Exchange is around 3.5. Examples are 6% for Bank of China, 3.6% for China Shenhua Energy Company Limited and 4.3% for Petrochina. So there is not a lot of difference between the Dow Jones and the Shanghai Stock Exchange here.
3) P/B ratio
The last key metric is book value. The price to book ratio of the 10 cheapest Dow Jones stocks is 2.5, while the price to book ratio at the Shanghai Stock Exchange is at 2 (Chart 4). The banks on the A-share market in particular have a very low price to book ratio. Another cheap stock is Sinopec Shanghai Petrochemical (NYSE:SHI) with a P/B ratio of 0.7. Nice to know is that the companies listed on the Tokyo Stock Exchange have recently hit a P/B ratio of 1.
Neither of the two (Dow Jones, Shanghai Composite) are bargains at this moment. P/E ratios are pretty high on average, dividend yields of 3% aren't particularly interesting. In contrast to this, we have price to book values which are historically low and this means that a lot of companies could be a value buy for investors.
The odd man out is Europe though. I'll show this in 3 charts.
The P/E ratio for Western European stocks is 11, far below world average (Chart 5).
|Chart 5: Europe vs. U.S. P/E ratio|
European dividend yields are historically high (Chart 6).
|Chart 6: European dividend yield relative to world equities|
The price to book ratio in Europe is almost around 1 now (Chart 7).
Given these low valuations in the European stock market, there are several key companies that are worth watching.
Total (NYSE:TOT) has dropped because of lower oil prices and pays a very good dividend of 5.9%. Nyrstar (EBR:NYR) has been plunging together with the zinc price and is noting far below book value (P/B = 0.47) and pays a dividend of 4%. If the zinc price goes up due to a recovery or Chinese stimulus, I expect this company to soar higher. Siemens (SI) is interesting because its share price has recently bottomed out. The company has announced a share repurchase program, which indicates its share price is inexpensive. Siemens pays a dividend of 4.3%.
Investors should know about the risks while investing in Europe. The valuations are cheap but there is a reason for this. Europe is officially in a recession and this could evolve into a depression as Italy's debt is rising at an accelerated pace. If Italy becomes the center of attention, there is no way it can be bailed out like Greece and Spain. The only way out is a debasement of the euro. As a consequence, this debasement of the currency will make European stock investments undesirable.
I recommend investors to start buying European equities like Marc Faber just did (Marc Faber never bought European stocks in his life until now). Investors can do this by buying the iShares MSCI Europe ex-UK (LON:IEUX) or the Vanguard MSCI Europe ETF. I think the cheap European stock valuations outweigh the European debt risk.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.