Good values are harder to find
Jason Stipp  |  28/05/2015Text size  Decrease  Increase  |  

Jason Stipp: I'm Jason Stipp for Morningstar. It's International Investing Week on Morningstar.com, and today we're taking a look at valuation levels across the globe with Morningstar markets editor Jeremy Glaser.
Jeremy, thanks for being here. Jeremy Glaser: You are welcome, Jason.

Stipp: Before we tour the world from a valuation perspective, let's talk about how we measure global valuations, the way we can extend our Analyst Ratings so that we can cover more of the world.

Glaser: Like you mentioned, we do have these analyst ratings--we have analysts who are covering stocks in the United States and Europe and Asia. Our research team has created a quantitative model that extends those ratings and tries to extrapolate what they think our ratings would be for stocks that we don't cover - markets that we don't have analysts for or stocks that are just too small for us to have full analyst coverage on. And using that data, we're able to get a snapshot of what equity valuations look like across the world.

Stipp: Let's unfold the map and start in Europe. Stock markets there have done pretty well. What do valuations look like, though?

Glaser: This has been one of the big turnarounds. Europe was trading at a pretty big discount to the United States in terms of valuations for a while, and that gap has disappeared. In fact, Europe looks more expensive right now. Overall, we think it's trading at a 4.6% premium versus a 1.2% premium in the United States.

Stipp: What was driving some of that outperformance that we were seeing in Europe?

Glaser: A lot of it was just a better outlook for European growth. We've seen signs that a lot of the worries about recession and deflation in Europe have really receded, and that's being caused a lot by exports. The European Central Bank obviously launched its quantitative-easing program. That has really helped keep the euro very low against the dollar. It has boosted export markets, and that has been a big boon for those economies. We are starting to see that in the data. I think that got investors excited. QE also tends to boost asset prices, so that was a big factor there.
Then, also, worries about Greece have become a slightly less pronounced. I think that there is more of a sense that the issues there are really ring-fenced so that if Greece were to exit the euro, it would be something that could be contained and [won't lead to some] sort of systemic risk across the rest of the continent.

Stipp: So, all of Europe is looking somewhat overvalued, but when you dig in, country by country, there is some differentiation.

Glaser: Yes, there is. You look at a country like Germany, which is more than 9 per cent overvalued, and that looks much more stretched than, say, Greece at 5 per cent undervalued. Though, there are obviously some issues [in Greece] that might mean there isn't a big enough margin of safety to really go all in. Emerging Europe looks about fairly valued right now--Poland at 1.5 per cent overvalued and Turkey at 2 per cent overvalued.

Stipp: So, if you are paying up a little bit for Europe as a whole, you are really paying up if you are going to Asia; those markets, on average, look pretty overvalued.

Glaser: Asia looks quite expensive. Eighteen percent overvalued for the entire region, and that's really driven by China. The Chinese market is 38 per cent overvalued, which is even up from where it was a month ago.

Stipp: And why do we think the Chinese market has been doing so well?

Glaser: This is kind of an interesting one, because China's economy has not been doing all that well. We're seeing signs of a pretty significant slowing there. We actually talked to Francisco Torralba about this - he is a senior economist at Morningstar Investment Management. He really thinks a lot of this is being driven by speculation, it's being driven by margin trading, and a lot of what's happening in the mainland Chinese market is not really being driven by fundamentals. It does look quite stretched.

Stipp: Hong Kong and Japan - not quite as overvalued-looking, but they also do look pricey.

Glaser: Hong Kong at more than 11 per cent and Japan at more than 7 per cent don't look cheap. And in Japan in particular, I think there are still a lot of question marks about if Abenomics - this three-pronged approach to restarting Japanese growth - will be successful or not. The market still thinks the answer is yes, but the jury is still very much out.

Stipp: Closer to home, how do valuation levels in Latin America and South America look?

Glaser: Not a lot of particularly great value is there, either. Argentina looks to be more than 7 per cent overvalued; Brazil is at more than 3 per cent. So, there's not a lot of opportunity there, either.

Stipp: So, when you wrap this all together, looking across the globe at where the valuation levels are, where are risks are, what's the takeaway?

Glaser: I think the takeaway is that there is not a region that looks like a great opportunity versus others. That was the case with Europe for some time, and that story is very much done. Asia, as you mentioned, looks quite stretched. So, I think for international-stock investors, they really have to think about why they are investing abroad, because right now valuation is not going to be the primary reason to do that. Is it a diversification benefit that you are looking for? Are there individual firms that you think are undervalued or that you think have great businesses that you want to invest in? I think those are the questions you have to answer. Just going out looking for cheap stocks or thinking a whole region looks cheap, though, based on our research, we just don't think that that is really the strategy that's going to work right now, given how expensive everything looks.

Stipp: Very interesting tour of the world from a valuation perspective. Thanks for joining me, Jeremy.

Glaser: You are welcome, Jason.

Stipp: For Morningstar, I'm Jason Stipp. Thanks for watching.

 

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