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.

Global Valuations - where to look?

One of the things that GS - to its credit - does well are the weekly kickstart series.

In conjunction with the GMO asset class forecasts I find them a useful way to scan for cheap markets and then from there rummage around for ideas. I've also thrown in the weekly GEM valuations from CS as well as a cross check.

Here's a quick rummage through:

In terms of 12-mo performance LatAm has been a shocker: Brazil, Peru, and Chile all off. (Amusingly, perennial econ basket case Argentina seems to be doing quite well and Peru is expensive on a CAPE basis as Mebane Faber points out.) Elsewhere, in some of the more exotic, off-piste frontier markets we have: Egypt, Jordan and Morocco, plus some Central/Eastern European names like the Czech Republic, all racking up bad numbers. And then finally, the big daddy of the GEMs, China.

Looking at historical valuations we can see China, Taiwan and Korea stand out as cheap in Asia and then looking to the Middle East, Egypt and Morocco are both cheap on a valuation and relative-to-history-basis. Brazil actually doesn't appear so cheap though and then we have markets like perma-cheap Russia and Hungary in Europe. Going back to Asia Hong Kong, China and Korea all look cheap on a historical basis too. Given China is hard to invest in without licenses then the easiest focus is Korea and HK.

Admittedly, Korea is always quite a cheap market and it has also been taking a bit of a downgrade on earnings forecasts, for what it's worth. 

It is interesting, if perhaps unsurprising to also note, that Korea, China and Taiwan are also the biggest underweights among GEM fund managers, according to the following chart from Citi (via BDT Invest).

In Euro-land the whole place looks pretty cheap, especially compared to some of the more hardcore frontier-markets and (in theory) should have less governance issues. Spain and Italy are both available for below book, as interestingly is Norway and neither France nor Germany appear expensive at first glance on an earnings basis.

As for Japan... try as I might, it's a little hard to get super excited. OK so they may or may not get out of deflation, which could tip multiples but the market doesn't look that cheap especially on a historical basis and when compared to the rest of Asia. That's not to say there aren't cheap stocks there but I figure for now there are cheaper and easier places to look. (I.e. Europe, Korea, HK and possibly places like Brazil, Taiwan, Morocco, and parts of Eastern Europe)

Looking at the latest GMO seven-year forecast we can see mavens from Boston are quite optimistic about the prospects for emerging market equities. I am not quite sure how they define emerging market but it is noteworthy the level of returns they are forecasting for the asset class. I would also note that The Economist ran a fairly bearish cover on the GEM space only a few weeks back, which I believe is quite a good contrarian signal.

(As smart as the chaps at The Economist are - I have a few friends writing for them and even toyed with the idea of writing for them at one point, hell, to it's credit it is pretty much the only news weekly left! - they remain a weekly magazine and getting stuff onto the front cover takes time hence it remains in my book a contrarian signal. If you need confirmation look at this cover from March 1999, which was published just as crude went parabolic.)

So in conclusion, I am tempted by the valuations in Europe (specifically France, Italy, Spain, Norway and Germany), Korea, and HK; possibly Taiwan and casting the net a little further afield potentially Brazil and Morocco. Obviously, this is a starting point so the trick from here is to look at current accounts, credit growth etc. in these markets.

Oh a prettier way to look at this all may be Damodaran's heat map, although TBH I am a little surprised at the multiples being thrown off by it. Oh well at least it look's pretty and it does also suggest Korea, China and Taiwan are cheap but little surprised with some of the reads in Europe and Brazil. Also is Nigeria that cheap?