A more granular look at some of the cheaper countries

Countries that are at a price to book well below their own average typically do better than average going forward.” Steve said. “I’ve found that almost all countries come back within six years, absent confiscation.” A country’s current price to book value relative to its historical average — normalized to adjust for changes in sector mix and political risk over time — became the model’s most heavily weighted factor."

	Current Trailing PBR	5-year Average	DISCOUNT/PREMIUM
Morocco	2.1	4.3	-51.2%
Peru	2.1	3.7	-43.2%
Czech	1.2	1.9	-36.8%
China	1.4	2	-30.0%
Russia	0.7	1	-30.0%
India	2.3	2.9	-20.7%
Hungary	0.9	1.1	-18.2%
Brazil	1.4	1.7	-17.6%
Chile	1.9	2.3	-17.4%
Korea	1.1	1.3	-15.4%
Egypt	1.5	1.7	-11.8%
Poland	1.3	1.4	-7.1%
Turkey	1.6	1.7	-5.9%
Indonesia	3.5	3.7	-5.4%
Colombia	1.9	1.9	0.0%
Taiwan	1.8	1.8	0.0%
Malaysia	2.2	2.1	4.8%
Mexico	2.9	2.7	7.4%
South Africa	2.5	2.3	8.7%
Thailand	2.3	2	15.0%
Philippines	3.2	2.7	18.5%
Pakistan	2.6	1.9	36.8%
Source: Credit Suisse

Using the Truffle Hound strategy and the Credit Suisse weekly valuations one can see that Russia, China, the Czech Republic, Peru and Morocco are all cheap. More broadly, using earnings and their 5-year average multiple, Taiwan and Korea look cheap as well as Europe (specifically France, Italy, Spain, Norway and Germany).

"mean reversion of even the most undervalued country could be offset by declines in that country’s currency... two factors that worked well and were relatively easy to calculate. The first was a country’s current account balance. “Bad things tend to happen to countries with large current account deficits, and good things tend to happen to countries with large current account surpluses,” he said. The second was its currency’s purchasing power parity (PPP) relative to other currencies... Steve started out by simply using the Big Mac Index to measure a country’s PPP, but he later switched to IMF statistics, adding a linear adjustment for GDP per capita."

Here's the Big Mac Index, with the relevant countries flagged and then a closer look at the trends in PPP over/undervaluation. For the full-blown cool interactive graphics try here


Now I'm unsure what the linear adjustment TH uses to the data to adjust for GDP/capita is - I may try and reverse engineer this at some point. But one can eyeball the countries and offset this in one's head against GDP/capita vs. the US to come up with a crude adjustment

MOROCCO

For some annoying reason, while Morocco does have MacDonald's The Economist doesn't calculate le Big Mac du Maroc's PPP and the Moroccan MaccyD's doesn't say what the effing things cost either!! However, it does look like a Big Mac cost about 47 dirhams back in April 2012 and perhaps as much as 65 dirhams in April 2013, according to Twitter. 

At the current (as of 12/08/2013) FX rate a $4.56 Big Mac should be 38.2 dirhams. Whichever way you cut it a 47 or 65 dirham Big Mac looks very overvalued, either about 23% or 70%, and this is more problematic when you consider that PPP should in theory understate the value of a lower GDP-capita country due to the non-tradeable goods sector. Indeed back in 2006 - when The Economist actually did put the Moroccans in the index - the Dirham actually seemed reasonably valued/slightly undervalued.

The overvaluation appears to be primarily due to the Moroccans pegging the dirham to a basket of currencies (page four - Natixis does some pretty decent research on Morocco btw). As you can see from the 10-year USDMAD chart the Dirham hasn't really moved over the time frame. My calculation off the Big Mac index implies the currency should be either at 10.31 or even 14.25 to the dollar. Even the lower estimate is way above where the MAD has traded at over the past decade.

Having not looked at their FX reserves I wonder how long the authorities can keep this up for? Moroccan stocks better be cheap to compensate for this, I am tempted to file in the wastepaper bin for now... (on a side note I've always found it puzzling how Arisaig can be comfortable in investing in things like Central Laitiere and Brasseries du Maroc at such high multiples, especially if the macro looks so rickety)



PERU

Peru is slightly harder to pin down, they've clearly been running higher current account deficits since 2006, but this has been offset by brisk economic growth. However, I suspect a fair amount of the growth has been due to it being reasonably levered into the Chinese commodity supercycle, which is probably drawing to a close so there is scope for the current account to deficit to deteriorate as a % of GDP. That having said, the market is clearly cheap, on a PPP-basis the currency looks undervalued (unlike Morocco); and the CA deficit as a % of GDP doesn't appear to be insanely onerous at this point.

CZECH

The Czech Republic is notable for both its undervaluation on a historical PBR  basis (-37%) and the PPP undervaluation against the dollar. They do run a current account deficit, but the thing seems to hauling its ass out of the pit, making successively lower lows (sound like a bit of a chartist there) of late as it trends back to surplus. Indeed, the deficit seems to be reasonably cyclical. Not knowing anything about their economy I wonder if they are continuing to climb out of the current account deficit pit or are about to fall back into it?


RUSSIA

The ruble seems to have been constantly cheap on a PPP basis over the past decade, and seems to be nearer the lower end of its historic PPP-trading band, for what that's worth. Current Account surpluses though have been coming in smaller as a % of GDP for a while, although the actual current account expressed in USD is pretty volatile and seems (to my eyeballs, at least) afflicted by a good deal of seasonality. That having said, they still run a solid current account surplus, have an undervalued currency and their stock market is not just cheap in real terms (i.e., less than book and low single-digit earnings) but also on a relative historical basis.

Here are two interesting pieces on Russia:

1. The market being cheap here at ETF Trends

2. The country being a source of relative calm vs. other GEMs as noted by the FT

“The glory of Russia is that it runs a current account surplus and the fiscal deficit is very low. Moreover, as a result of developments in the Middle East, oil prices are holding up” said Kingsmill Bond, chief strategist at Russian state bank Sberbank’s investment banking arm. “Consequently the rouble is able to avoid the pressures faced by other currencies.”

EUROZONE

The Economist's Big Mac index flags the Euro as at approximately fair value, although it doesn't say what they took as the Eurozone average burger price in their data set. Although it would appear to be the cost of ein Big Mac in Deutschland is EUR3.64.

Thankfully for me Bruegel have a done a lot of the heavy lifting and analysis in  a series of interesting posts here and here. The basic thrust seems to be prices in Italy and France require some adjustment (i.e., the French and Italian Euro/prices are overvalued relative to the rest of the zone). Spain and Greece seem cheap, and Germany fairly valued. 

There seems to be quite a lot happening in the Eurozone so I am going to handle the place in a separate post looking at the current account deficits and try and get some historical data on the PBR discounts there. 

TAIWAN 

Taiwan runs some pretty punchy current account surpluses and has been sporting a very undervalued FX rate for a while too. If anything, it looks to be on a long-term downtrend. On a PBR basis though it looks reasonably valued. 

KOREA

Korea on the other hand, is trading well at the bottom of its five-year PBR band based on GS' kickstart data and it's been running some decent surpluses with a consistently cheap FX rate. This could be quite a promising market.