Where Are the Best Global Values Right Now? | #3

Episode Summary

Executive Summary: Meb Faber and co-host Jeff Rimsberg discuss global stock market valuation as a long-term forecasting tool, centered on the Shiller CAPE ratio and related indicators. The core message is that U.S. stocks are expensive, foreign markets are cheaper, and investors should diversify globally, tilt toward value, and manage expectations rather than try to time short-term moves.

Main Topics: Shiller CAPE as a long-term valuation gauge (Priority: 5/5): The episode explains the CAPE ratio, its historical basis, and why it is better suited to forecasting 10-year outcomes than short-term market timing. Faber emphasizes it as a probabilistic tool that shifts expected returns and drawdown risk. U.S. stock market valuations and expected returns (Priority: 5/5): The U.S. market is portrayed as expensive but not yet a full bubble. The speakers discuss how elevated CAPE and price-to-sales ratios imply low future returns relative to history. Global valuation dispersion and country selection (Priority: 5/5): The conversation broadens from the U.S. to foreign developed and emerging markets, arguing that cheap countries historically outperform expensive ones and that investors should use baskets of countries rather than single names. Home-country bias and portfolio construction (Priority: 4/5): Faber argues most investors are overallocated to their home market, especially the U.S., and should begin with a globally market-cap-weighted portfolio before tilting by value. Behavioral and career-risk challenges (Priority: 4/5): The episode stresses that cheap assets often have terrible news flow and can be hard to hold, creating career risk for advisors and emotional discomfort for investors even when expected returns are attractive. Currency considerations in global investing (Priority: 3/5): The speakers discuss foreign-currency risk and note that while currencies add volatility, they are often not a reason to avoid global equities; the choice to hedge should be consistent over time.

Key Arguments: Valuation is most useful over the same horizon it measures; CAPE is meant for roughly 10-year expectations, not next-month timing. Higher starting valuations generally lead to lower future returns and larger drawdowns, while low valuations tend to produce higher future returns. The U.S. market is expensive relative to history, with expected nominal returns around 4% to 5%, which is below typical long-run expectations. Multiple valuation indicators should align at extremes; CAPE, price-to-sales, and household stock allocation all point to an expensive U.S. market. Foreign developed and emerging markets offer better expected returns than the U.S. because they trade at lower valuations. A globally diversified investor should start near a 50/50 U.S.-foreign split instead of the common home-country-biased allocation. The cheapest countries often have the worst news flow, which is why value investing works and why it is emotionally difficult. Investing in a basket of the cheapest countries is safer than concentrating in one distressed market because individual countries can always get cheaper. Currency volatility matters, but for long-term equity investors it is usually secondary to valuation and diversification decisions. Market-cap weighting can be a poor default because it mechanically concentrates money in the most expensive and largest assets rather than the cheapest opportunities.

Data Points: Average CAPE ratio: 16-17 - Historical average for U.S. stocks since the late 19th century. Lowest CAPE mentioned: Around 5 - Observed around the Great Depression era in the U.S. Peak CAPE in 1999: 45 - U.S. stock market peak during the late-1990s tech bubble. U.S. CAPE in 2008-2009: Around 13 - Valuation trough during the financial crisis. Current U.S. CAPE: Around 25 - State of the U.S. market at the time of the episode. Expected U.S. nominal return: About 4% per year - Implied by current CAPE valuation. Historical U.S. real return: About 6.5% per year - Long-run real stock market return cited back to 1900. Median S&P 500 price-to-sales: 2.0 - Described as the highest ever and above the long-term average. Median S&P 500 price-to-sales historical average: 0.9 - Long-term average going back to the 1960s. Households' U.S. stock allocation: Around 70% average in the room - Used to illustrate home-country bias; the U.S. market is about half of global market cap. Best starting-point real return: 16% per year - Future 10-year real return from the best historical starting points. Worst starting-point real return: -3% per year - Future 10-year real return from the worst historical starting points. Best starting-point average CAPE: 11 - Average CAPE of the 10 best historical starting points. Worst starting-point average CAPE: 23 - Average CAPE of the 10 worst historical starting points. High-CAPE bubble threshold: Above 45 - Defined as true bubble territory with negative expected returns. Yellow warning level: 30 - Faber’s threshold for caution in U.S. equities. Red stop level: 40 - Faber’s threshold for avoiding stocks entirely. Foreign developed CAPE: Around 16-17 - Described as reasonably valued. Foreign emerging CAPE: Around 13 - Presented as cheap relative to the U.S. Cheapest country bucket CAPE: Around 9 - One of the lowest levels observed in the global database. Russia CAPE: 5 - Named as the cheapest country in the world at the time. Brazil CAPE: 8 - Also cited as very cheap. Poland CAPE: 9 - Listed among the cheapest countries. Czech Republic CAPE: 9 - Listed among the cheapest countries. Turkey CAPE: 10 - Listed among the cheapest countries. Egypt CAPE: 10 - Listed among the cheapest countries. Hungary/Portugal/Spain CAPE: 11 - Part of the cheapest global valuation cohort. Japan bubble CAPE: 95 - Peak valuation in the late 1980s, used as the biggest bubble example. Japan valuation work-off: 20 years - Approximate time required to normalize after the bubble burst. U.S. bubble work-off: 9 years - Time it took for the U.S. to work off the 2000 bubble. Foreign developed vs. U.S. market cap: About 50/50 - Global market-cap split mentioned as a reference for portfolio construction. Largest U.S. company underperformance: About 3 percentage points per year - Research Affiliates finding cited for the largest U.S. stock and sector leaders. Countries in the global CAPE database: About 45 - Number of countries screened for global valuation. Best performance when CAPE < 7: Over 20% per year - Future 1-, 3-, and 5-year returns in extreme cheapness. Five-year performance when CAPE < 10: 120% average - Research Affiliates/PIMCO study cited near the end. Emerging markets vs. U.S. GDP: Roughly same GDP, 1/4 the market cap, 10x the population - Used to justify long-term opportunity in emerging markets.

Pivotal Quotes: "Valuation is not something traditionally that's going to help you in the next month or even year." — Meb Faber: Explaining why CAPE is a long-horizon tool rather than a timing indicator. "No one ever does. One of the reasons is because it feels comfortable to have US assets. It's what you know." — Meb Faber: Discussing home-country bias and why investors overweight domestic stocks. "Investing is the only business when things go on sale, everyone runs out of the store." — Meb Faber: Describing the behavioral difficulty of buying distressed markets.

Implications: Investors should lower domestic bias, accept lower near-term U.S. return expectations, and consider global value tilts. Cheap markets may stay cheap and look ugly, but history suggests they offer the best long-term odds.