It’s time to look east for value

While US investors continue to drive their money away from the bond market in the direction of the ever rising stock market to exploit what they think is a great profit opportunity, everybody’s favourite Central Banker – Mr Ben Bernanke is most likely having a glass of California’s best whilst congratulating himself on the achievements of his trillion-dollar + QE policy! But within this group of investors who continue to throw their funds to the stock market, one “sage”, Mr Warren Buffet most certainly is not.

The equity market is, unarguably, overvalued on all traditional measures, and unless you use alternative ones (like our friends the “anal”ysts did during the 1990s – remember how that ended?!), there is scant value to be found anyway except the mining sector (our favourite subject these days!!).

When the stock market was hit by the financial bubble in 2007, the cyclical adjusted P/E ratio (or simply CAPE), was around 27x – not as high as during the tech bubble, but still high when compared with the historical mean of 16.5x. The financial crisis helped burst the valuation and pushed the CAPE ratio back to its historical mean. Back then it was definitely worth investing in shares for the long-term as you would have been paying a reasonable amount for future profits as opposed to an excessive measure. The problem is that the FED has accelerated the revaluation process and in the process boosted the market to an unsustainable level within too short a time interval. Earnings haven’t had time to catch up with the price increase, resulting in the CAPE ratio rising back to the 25x level. Consequently, there is now a dearth of opportunities for investors looking for real value. If you’re a speculator, then I guess the CAPE index means nothing to you, and every market represents a profit opportunity… But, if you’re more like the best investor of all time Warren Buffet, it’s time to look elsewhere for the right opportunities.

Asian economies have been a rare engine of growth in recent years, in contrast to Europe and the US. They have industrialised their economies at an increasing pace over the last 20 years, providing us with cheap products that our manufacturers could never compete with. But things are changing fast, and from being an investment-driven economy they will change into consumer-driven economies, meaning they will also be looking for products to buy. Their middle class is rising in number and according to OECD projection, the Asian middle class will grow in number from 500 million to 3 billion during the next two decades. Why do you think Apple was trying to introduce its iPhone and so many US retailers are trying to set foot into mainland China? They are anticipating this secular opportunity…

Unfortunately, Western companies seem to lack the know-how to succeed, certainly at least up to now, and many have failed so far. But, there are opportunities for investors considering local companies, particularly those that are more related to consumer goods.

During the financial crisis, consumer-orientated Asian companies continued to still do well as consumer spending was growing at between 5% and 10%. If you now add to this the opportunity created by a middle class explosion, then it’s definitely time to consider reallocating a good proportion of your portfolio to this region.

However, caution is required as simply blindly investing in Asian indices will not be enough. The MSCI ex-Japan index for example, is made up of several low-margin export companies, state-run Chinese banks and some inefficient businesses. You will need to be much more selective and look for companies on a case by case basis and remember to bear in mind that this middle class explosion is not just happening in China, but across multiple Asian countries – India and Indonesia, for example. Problem is navigating the corporate minefield as standards of ethics and shareholder rights are very different in these countries than in the UK (AIM market excepted of course!!) and as Fidelity’s Anthony Bolton found out too to his cost in recent years…