In my previous two columns, I made the case for selling US equities based on their overvaluation. Some of you found this interesting, while others criticized my decision. Admittedly, there are two issues that arise from this: one that is potentially costly, and the other that is concerning on an existential level.
The first problem is that I am required to wait 30 days before making any changes to my portfolio after writing about them. This means I am dependent on the S&P 500 maintaining its current level for a little while longer. Fortunately, it reached a 15-month high this week and there have been positive indicators such as strong US consumer confidence and housing data. Additionally, the Fed did not say anything that would cause a significant decline in equities. So, I hope for more of the same!
The second problem is the logical implication of selling off the US stock market due to its overvaluation. If I am correct in my assessment, it suggests that other equity indices will also experience a crash. Some might even argue that this collapse will be so severe that it’s time to prepare for the worst. However, in the best-case scenario, even markets with compelling valuations like the UK or Japan would suffer. In the 2008 financial crisis, for example, the Footsie and Nikkei dropped 30% and 40%, respectively, despite the crisis originating in the US.
Therefore, the only reason to hold onto my other stock ETFs while selling off my S&P 500 fund is if I believe that the US decline will be less severe than indicated by the Cape and Q ratios that I focused on. In my optimistic view, the S&P 500 has always bounced back, even during previous bear markets. Besides, who would be left to read this column if everyone formed a militia instead?
So, let’s agree that it is still reasonable to consider owning other equity funds. This brings me to the possibility of investing in Asia ex-Japan. It is often argued that a strong US market restricts investors from buying into Asia and driving up prices. I encountered this reasoning frequently when managing global ex-US portfolios.
However, this belief is nonsense when you consider that for every buyer, there is a seller. The idea that Asia benefits from the absence of interest in Wall Street is flawed. Nevertheless, it becomes harder to promote Asian funds when the US market is booming.
Historically, from 2002 to 2012, while the S&P 500 returned 6.5% annually, $60 billion was invested in Asian ex-Japan funds. In the past decade, US equities grew at twice the rate, and $25 billion was withdrawn from Asian funds. If the S&P 500 experiences a decline, asset managers will rush to sell Asian stocks to overseas investors. Interestingly, many of these managers stress the importance of having a “big local presence” when promoting their superiority.
Academics, however, agree that this proximity to the action does not significantly impact performance. Analysts running US equities from Frankfurt or managing emerging market debt funds in Sydney have just as much chance of outperforming or underperforming. In fact, sometimes being local is a disadvantage.
Why do I mention this? Because in my 30 years of experience, I have observed this problem most in Asia. While it may not affect the selection of individual shares, living in the region tends to make everyone bullish. Perhaps it’s something in the rice or the buzz surrounding Asia’s exceptional growth rates. But ultimately, what matters is the returns on equity, and Asia consistently underperforms compared to developed equity indices.
Asia is always seen as the next big thing, but recent research reports continue to highlight this optimism despite poor performance. The reasons to invest in Asia are often repetitive and outdated. The region’s large population, rising middle class, attractive ratios, internet penetration, and a supposed shift in focus on cash flows are frequently mentioned. However, my MSCI Asia ETF has declined by another 2% this year and has lagged behind its equivalent MSCI World fund by 50% over the past decade. While Asia may be cheap compared to something extremely expensive, this isn’t the most compelling advertisement. I need more reasons to believe that Asia ex-Japan can bring me profits.
There are possibly two reasons to be hopeful. Firstly, a weaker dollar could benefit Asian markets, as translated returns are amplified and appreciating domestic currencies boost local equity markets. Secondly, Chinese stocks, which still make up a significant portion of the benchmark, could experience a resurgence after a difficult year and a half. Therefore, for now, my gut feeling tells me to stick with Asia ex-Japan. However, history has often proved me wrong.
The author, Stuart Kirk, is a former portfolio manager. You can contact him via email at [email protected] or on Twitter at @stuartkirk__.
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