I’ve got some good news for you and some bad news. We’ll get the bad news out of the way first.
Using the ratio of total market cap to GDP, the U.S. equity markets are looking expensive again. This metric—which is one that Warren Buffett himself claims to use as a general gauge of market valuation—suggests that U.S. stocks are priced to return a measly 2.1% per year going forward.
The good news, however, is that many of my favorite international markets are priced to generate fantastic returns going forward. Spain—which I wrote about last week—is priced to deliver returns of 11.4%. Singapore is priced to deliver returns of 16.7%.
And the implied returns on several emerging markets is jaw-dropping. China—which I wrote about last month—is priced to deliver annual returns of 34.3% per year.
Some major caveats are in order here. These estimates are for long-term returns based on current market caps, and the relationship between GDP and market cap is constantly evolving. There is no cardinal rule of nature that says that the future has to look like the past. And with capital markets evolving—and with the mega-cap multinationals that tend to dominate cap-weighted indices getting a larger and larger proportion of their revenues from outside their home markets—I would expect market caps to gradually trend upward as a percentage of GDP. Furthermore, GuruFocus made assumptions that future GDP growth will be the same as past growth. In a country like China—whose growth is slowing—this will massively overstate the implied future returns. And in Europe—where growth has been all but nonexistent for over half a decade—it will probably understate implied future returns.
So, we should take these estimates with a very large grain of salt and understand that they are exactly that: estimates.
Still, these valuations do support my investment thesis for the remainder of 2013 and 2014: European and emerging market equities should vastly outperform their American peers. In my Tactical ETF portfolios I have dedicated positions to the iShares MSCI Spain ETF (EWP) and the iShares China Large Cap ETF (FXI). Both have been in correction mode for most of the past month. That’s ok. Use the weakness as an opportunity to accumulate more shares.
Charles Lewis Sizemore, CFA, is the chief investment officer of the investment firm Sizemore Capital Management. Click here to receive his FREE 8-part investing series that will not only show you which sectors will soar but also which stocks will deliver the highest returns. The series starts November 5 and includes a FREE copy of his 2014 Macro Trend Profit Report.
This article first appeared on Sizemore Insights as Gameplan for 2014: Buy Europe and Emerging Markets