One of the world's most closely followed value investors thinks there's little value left when it comes to stocks in Canada and the United States.
Charles Brandes, the billionaire founder and chairman of Brandes Investment Partners, is predicting that both countries will underperform Europe and emerging markets over the next three years.
Much of his argument, which was given at a CFA Society Toronto dinner this week, rests on valuations. He notes that the cyclically adjusted Shiller price-to-earnings ratio -- which compares stock prices to 10-year moving averages of earnings in order to smooth out the impact of the business cycle -- now stands at about 25 times in the U.S. That's way above the median of the past 134 years of 15.9 times.
Meanwhile, U.S. corporate profit margins are elevated and both investor and consumer confidence numbers are high - which suggests to him that the market is looking rather lofty.
In Canada, he notes that forward price-to-earnings ratios are higher than that in Western Europe, household debt to income is at an uncomfortable level of more than 160 per cent, and financials and energy sectors are looking expensive. None of that is going to be market-friendly going forward, he suggests.
The situation is much different across the pond. "Value stocks are the most attractive in history in Europe," he told the audience of financial professions.
There, the cyclically adjusted price-to-earnings ratio is only 14.4 times versus the 30-year median of 17.5 times. Corporate profit margins in Europe are depressed. But Mr. Brandes is a strong believer in reversion to the mean - the widely held market theory that suggests prices and returns eventually move back towards long-term averages. European stocks have never been this cheap versus the U.S., when looking at the cyclically adjusted price to earnings, he says.
For emerging markets, he notes that stock prices -- as measured by the MSCI Emerging markets index of 23 countries -- are just below 1.5 times book value. That is almost down to where they were during the global financial crisis in 2008 and 2009. Over the last 20 years, they have only significantly fallen below current levels during the Asian crisis of 1998, when they briefly touched one times book value. He cautions, however, that not all emerging market countries are created equal, and investors need to make careful selections for where they put their money.
Fixed income is not the answer for investors who don't want to go overseas for their investments, according to Mr. Brandes. He predicts that equities overall will outperform bonds over the next 30 years by the widest margin on record.
He explained that there is an unusually large 3.7 percentage point gap right now between earnings yields, as measured by the MSCI World Index, and the 10-year U.S. Treasury yield. That suggests treasury yields have a long way to catch up to earnings – and as yields rise, bond prices fall.
Mr. Brandes also predicted at the dinner that investor interest over the next five years will shift back towards active strategies. He believes the big influx of money into passive investing will increase risks for correlated market movements, and investors will become more aware of these and other problems with non-active strategies.
Darcy Keith