Country Investing Based on CAPE

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Park
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Country Investing Based on CAPE

Post by Park » 10 Jan 2018 02:55

http://www.fortunefinancialadvisors.com ... t-rotation

"Consider the case of Sweden which, hit a Japan-like CAPE high of 79 in early 2000. At the same time, the U.S. was also at its all-time high, but seemingly a relative bargain at just 47. Since then through 2017, U.S. shares have indeed outperformed Swedish shares, but it would have taken the patience of saint to wait so long; despite the huge premium, MSCI Sweden outperformed the MSCI USA index by more than 240 basis points annually over the ten year period starting in March 2000"

nother example would be the case of Switzerland, which reached a peak CAPE of almost 60 in July of 1998, versus 40 for the U.S. Despite the discount, U.S. shares trailed Swiss shares by 1.7% per year over the next ten years.

It bears repeating that currency plays a huge role in relative returns between two global markets...the Swedish krona and the Swiss franc appreciated versus the dollar in the aftermath of the tech bust, helping Swedish and Swiss shares offset their rich valuation compared to the U.S."

Country investing by CAPE is a bet on reversion to mean. But reversion to mean is a noisy signal that works better with market of 100s-1000s of stocks versus 10s of countries. Also, mean reversion for countries, as measured by CAPE, takes 5-10 years approximately. Mean reversion for stocks takes 1 year, and is gone by around 5 years. As mentioned, currency complicates the picture, although it complicates both stocks and countries outside Canada.

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Re: Country Investing Based on CAPE

Post by Peculiar_Investor » 10 Jan 2018 07:39

An interesting point of view and data set, but I'm not sure how relevant would be to an individual investor. From my reading of FWF'ers, they fall mostly into two camps. Camp A are those that index, who for the most part tend to use broad-based indexes such as S&P/TSX, S&P500 and MSCI EAFE (or equivalent). Camp B are those that are stock pickers, who for the most part tend to pick individual stocks in the North America stock markets and then use broad-based indexes for their ex-North America allocation. They might sprinkle in some ADRs for ex-North America.

I'm not sure how I would use this country investing based on CAPE, as that would require a significant amount of slice and dice when setting and maintaining an asset allocation. At most I would suggest that most FWF'ers, if they are slice-and-dice for ex-North America, they would only be considering a split between ex-North America Developed Markets (EAFE for example) and Emerging Markets, not down to the country level.

Do you think that individual investors would be well served to slice-and-dice to the country level? I think that is best left to the institutional investor.
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Park
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Re: Country Investing Based on CAPE

Post by Park » 10 Jan 2018 08:43

"A quantitative value investor will try to identify the stocks exhibiting value characteristics (e.g. low P/E, P/B, P/S, et cetera) and then buy a large enough basket of them where the aggregate value signal remains strong, but there is sufficient diversification to limit idiosyncratic risk...for regional bets based upon valuation, there is not much to diversify: you’re effectively making one, big single bet.

First, in the traditional value factor, the dividing line is the characteristic in question: i.e. “cheapness.” All the stocks we buy are, by definition, relatively cheap. In the U.S. versus International case, both sides include both cheap and expensive stocks. We’re trying to express a valuation-driven trade but using very muddied instruments to do it.

Second, we’re using a dividing line that introduces a confounding risk factor. For the value factor, we generally expect both the cheap and the expensive portfolios to share similar characteristics...In the case of U.S. versus International, not only do we not expect the two baskets to share similar characteristics, but the construction of the trade ensures it.

valuation-driven market timing is really, really hard...Except – maybe – in the case where we’re seeing historically absurd, never-before-seen measures."

https://blog.thinknewfound.com/2017/11/ ... al-equity/


http://www.etf.com/sections/features-an ... nopaging=1

See Fig. 2 in link above. CAPE's ability to predict US stock market return is greatest at 1 years and progressively decreases with time. That's measured by the slope of the line. You'd expect that, as value investing is a reversion to the mean. By 30 years, returns will be similar to long term historical returns, which means that they'll be driven by earnings and not initial valuation. However, the problem is the dispersion at 1 year is great, and progressively decreases with time. For shorter time periods, factors other then valuation drive stock market returns. So there's a compromise between return and dispersion, with the sweet spot being 10-15 years?

The above is why value investing works best at the stock level, as opposed to industry or sector or country level or regional level. When you go to the industry/sector/country/regional level, you weaken the value signal. Also at the country level, it takes longer for the value signal to show up. I believe that at the sector level, it takes a similar amount of time as at the country level, although I'm not as certain about that.

What can CAPE be used for?

https://www.starcapital.de/fileadmin/us ... imling.pdf

Please see figure at the top of page 11. Historically when CAPE is greater than 60, real return over the next 10-15 years has been a maximum of about 2%. When CAPE is less than 10, it has been a minimum of 5%.

At extremes, CAPE or similar measures, might be used to market time. In between the extremes, CAPE might be used to slightly overweigh or underweigh when it comes to asset allocation. This is analogous to William Bernstein's overbalancing.

Another way to use CAPE is as follows, which assumes an active investing strategy. You might invest a small portion of your portfolio in cheap country ETFs, This assumes that you can't invest directly in the stocks of those countries. However, with brokers such as IB, foreign stock markets are becoming more accessible.

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Re: Country Investing Based on CAPE

Post by Taggart » 10 Jan 2018 17:14

Looking back to when I first started investing in the early 80's, there's only one professional value investor I can think of that may have done a fine job investing at the country level outside of North America and that's John Templeton, who has of course has long since passed away.

I used to play around with a few ADR's back in the 90's, but aside from a couple of big winners due to a frenzied bull market at the time, most of it was just a waste of time, getting nowhere fast. Entering the 2000's, aside from Canada, I completely lost interest in investing in individual foreign stocks.

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Re: Country Investing Based on CAPE

Post by AltaRed » 10 Jan 2018 17:16

Taggart wrote:
10 Jan 2018 17:14
Looking back to when I first started investing in the early 80's, there's only one professional value investor I can think of that may have done a fine job investing at the country level outside of North America and that's John Templeton, who has of course has long since passed away.
FWIW, I did pretty darn good with Templeton mutual funds in the '90s. It was time to go when Sir John left.
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Re: Country Investing Based on CAPE

Post by Taggart » 10 Jan 2018 17:29

AltaRed wrote:
10 Jan 2018 17:16


FWIW, I did pretty darn good with Templeton mutual funds in the '90s. It was time to go when Sir John left.
Yup. You got that one right AltaRed. There's a time for everything.

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Re: Country Investing Based on CAPE

Post by twa2w » 10 Jan 2018 20:25

Country investing based on CAPE? There is an etf for that.

I read about a year or so ago about an etf that was country CAPE based. ( it buys the index etf in countries a certain % below their long term average CAPE. don't believe the sell discipline was disclosed so I didn't look further)

Can't recall which one that was but Meb Faber does something along that line at Cambria investments - sort of a mix of country and individual stocks. Symbol is GVAL.

GVAL etf picks the bottom 25% of 45 countries based on metrics similiar to CAPE. The individual companies are picked from those countries using some type of value based metrics.

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