Why global investors should target cheap markets such as the UK
For investors looking for a fixed point in a world of constant change, value’s ‘North Star’ is currently highlighting a striking gap between the cheapest and most expensive countries in the world
Sailors battling stormy seas have always had the certainty of the North Star’s position to help them navigate their way to safety. With disruption everywhere and so much changing – technology, the climate, what at times can feel like the whole world – investors would really benefit from something similar to guide them. And, if they follow the discipline of value investing, they already have it.
The lens through which value investors have learned to view global stockmarkets is that, when all is said and done, the price you pay for something still matters. No matter how clever the idea or how interesting the stock or how dominant or disruptive its business model might be – in the long term, how much money you make is directly related to whether you pay a cheap, an average or an expensive price for the asset in the first place.
This idea is encapsulated in the following chart, which you may recognise from previous pieces, here on The Value Perspective, such as Why value investing works. It distils what is now a century and a half of US stockmarket data to illustrate the long-term relationship between the price you pay for a company and the stockmarket returns you ultimately see.
In this instance, the metric used is the cyclically-adjusted price/earnings or ‘Cape’ ratio but the chart would come out the same on any other measure of value, such as dividend yield or price to book. Each time, a very consistent relationship emerges – over the longer term, the lower the valuation you buy in at, the higher your return will be; and the higher the valuation you buy in at, the lower the return you will make.
150 years of history
As we say, this is 150 years of history, which takes in two world wars, a great depression, a global crisis, two tech bubbles and interest rates as high as 15% and as low as zero. And it includes the arrival of some of the most disruptive technology the world has ever seen – domestic electricity, the car, the plane, television, the microchip, the internet and the mobile phone.
No matter what this extraordinary litany of global change and disruption had to throw at it, however, that value-based relationship has held true. Not every month or every year, for sure – and yet, on average and over the longer term, the cheaper the price you pay for a business, the more money you make; and the higher the price you pay for a business, the less money you make.
Hold on, you might say – what about Tesla? What about Amazon? What about Google? It is important to note the above chart neither invalidates such stocks – nor is it invalidated by them. It takes such instances into account and it still works – on average and over the long term. Why? Because it is based on the one thing that never changes in a stockmarket wherever in the world it might be – human emotion.
Humans are human
Humans grow fearful and despondent – and then markets grow too cheap. And humans grow greedy and euphoric – and then markets grow too expensive. That never changes because humans are humans, which means you could look at how, say, the MSCI World index is valued today – a little above average, as it happens, with a Cape in the low 20s – and gauge the returns you might expect to make over the next decade.
But that would only make sense if you were planning to invest passively in the whole index – and who would want to do that? Well, OK, it turns out huge numbers of people would want to do that but, here on The Value Perspective, we have high hopes that we can do a bit better for our clients and so we focus our attentions and efforts on the cheaper parts of the market. You can see where in the world that takes us in the following chart.
Looking to the left of this Cape chart, as value investors instinctively do, we find the emerging markets, Spain and, perhaps most eye-catchingly, the UK, which is now as cheap versus the rest of the world as it has been in 50 years. Brexit, a service-based economy badly hit by Covid-19 and a surfeit of old-school financial and commodity-related stocks have, not surprisingly, seen the UK fall to the bottom of the global pecking order.
Beyond Brexit and Covid-19
That said, those looking to invest on a global basis now need to recognise things are beginning to look up for the UK. For one thing, Brexit is done and, for another, the country now boasts some of the highest Covid-19 vaccination rates in the world. It would be a stretch to suggest the outlook for the UK is amazing but does it really deserve to be one of the cheapest markets in the world? Here on The Value Perspective, we believe not.
In stark contrast, you can see the US, whose Cape ratio of 33x leaves it just below its tech boom valuations in the late 1990s. It has not quite made it into the far right-hand bucket, where it resided at its dotcom peak, but it is not far away. And while we would readily acknowledge the US is home to some of the most innovative businesses the world has ever seen, it now seems very likely investors are overpaying for these assets.
As we have noted before in articles such as Disruptors get disrupted too and Profiting from tech companies, the recent past has shown that, in due course, patient investors should have an opportunity to buy into many such assets at much better valuations. In the meantime, 150 years of history suggest global investors would do well to follow value’s North Star elsewhere to the long-term potential of cheaper markets, such as the UK.
Fund Manager, Equity Value
I joined Schroders in 2001, initially working as part of the Pan European research team providing insight and analysis on a broad range of sectors from Transport and Aerospace to Mining and Chemicals. In 2006, Kevin Murphy and I took over management of a fund that seeks to identify and exploit deeply out of favour investment opportunities. In 2010, Kevin and I also took over management of the team's flagship UK value fund seeking to offer income and capital growth.
The views and opinions displayed are those of Nick Kirrage, Andrew Lyddon, Kevin Murphy, Andrew Williams, Andrew Evans, Simon Adler, Juan Torres Rodriguez, Liam Nunn, Vera German and Roberta Barr, members of the Schroder Global Value Equity Team (the Value Perspective Team), and other independent commentators where stated.
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