Earlier in the week we looked at the relative overvaluation of the U.S. stock market vs. the rest of the world using a wide variety of value metrics. See: How Expensive Are U.S. Stocks Relative To Markets Around The World?Today we're going to strip out the value metrics and just look at one side of the equation; price. We'll be using charts put together by the excellent financial site; A Wealth Of Common Sense.
A large part of the reason why the U.S. market is relatively overpriced vs. the rest of the world.....is simply because the price has risen far more than other markets (remember price is half the equation). As we know, the average investor is naturally drawn to markets that have recently performed better than others like mosquitoes are drawn to a bug zapper.
The following chart shows the S&P 500 (the U.S. stock market), which has climbed well past its 2007 high and has been rising relentlessly for the better part of three years. It is where everyone in America wants to invest (see How The Home Bias Phenomenon Impacts Investors) and many speculators outside the U.S. want to invest right now.
The next charts show why there is relative value to be found outside the United States; these markets have not risen as relentlessly the past few years and have not crossed back above their 2007 highs.
Emerging Market Stocks:
European Stocks:
Asian Stocks:
Latin American Stocks:
The direction you believe these markets will move in the future depends on how you think the global economy and financial markets will behave in the years ahead. If you believe the global economy is just beginning to build up speed and will continue to expand in the years ahead, then there is an argument to be made to add positions to markets outside the United States which need to "catch up" in price performance.
If you believe the global economy will slow in the years ahead, you may want to consider exiting a portion of your global stock market portfolio and adding more cash or dry powder for a potential market decline. Under this scenario, in a worldwide sell-off, U.S. stocks would "catch down" to global stock markets and commodities (I am in this camp).
Under either scenario, based on relative value, an investor should not be holding the largest percentage of their stock holdings in U.S. stocks. If you are a momentum chaser, then the U.S. stock market is ideal because it has reached the euphoric blow off stage. If you are a value investor, then you should be exiting the U.S. market as quickly as possible.
The last bonus chart combines commodities and emerging market stocks. As you can see, they have tracked together over the past two decades mainly because emerging market countries are commodity producers and exporters. As commodity prices rise it positively impacts the revenue those countries receive. Click for larger image:
There has been a divergence over the past few months with emerging market stocks performing well while commodities have stagnated or declined.
You can look at this this divergence the same way we did for U.S. stocks vs. the world above. If you believe the global economy will grow at a faster pace in the years ahead, then commodities should "catch up" to the relative out performance of emerging market stocks.
If you believe the global economy will slow, then commodities are ahead of the curve on emerging market stocks which will soon "catch down."
I am somewhere in between. The largest position I continue to add to my portfolio is cash, while I layer in a smaller percentage of extremely sold off and hated commodities (mainly silver, agriculture grains, gold stocks and uranium stocks). My hope is that emerging markets "catch down" so I can use some of the dry powder in cash to enter those markets. The U.S. market is so far away from being even remotely close to undervaluation that there is no need to even pay attention to those stocks unless some enormous market crash brings them back down to earth (that is coming, so don't completely forget about them).
If you live in the United States, do your absolute best to think of the markets as a global financial environment. Do not let your mind wander back into the natural state of home bias.
