What or where in the world is cheap?

- High beta/highly leveraged/speculative names seem to be performing best at the moment, especially in developed markets.
- Sentiment, at least as evidenced by ETF flows, seems to have turned in favor of GEMs since early Q2 and perhaps has begun to sour vis-a-vis Europe (although it's a little early to tell)
- Smarter people than me seem to think US high quality and perhaps EM equities offer value from here.
- On a PB basis there appears to be value in LatAm, Central and Eastern Europe and AXJ.

It’s worthwhile looking at what has and hasn’t been doing well at the moment. Goldman’s kickstart series shows that US style-wise companies with weak balance sheets, high beta and high operating leverage have done best YTD. “Quality” companies – i.e. those with strong balance sheets, high revenue growth… and notably low HF concentration (in the US, at least) – have been the worst performers, alongside those companies that generate significant revenue from the BRICs and EM.



It was also interesting to listen to Stanley Druckenmiller in this interview (about 17 minutes in) –
“As for IPOs we are right on the border of where were in 1999; 83% of IPOs that went public had not earned a dime, today that is 80%. It’s the only other time in history we’ve approached that”

To me that is also another facet of the move into more speculative, high beta names. I actually came across a good visualization of this a few months back in an investor letter I was sent by a friend.



Interestingly, the IPO market seems to breaking down a bit according to Renaissance Capital
US IPO Pricing Recap: 15 IPOs in the most active week since 2007; 66% ended at or below IPO price

Now admittedly, Alibaba IS extremely profitable, but I think it is worth keeping an eye on the company as a barometer of IPO and more general market sentiment: it’s huge (so will test appetite to take down lots of new issuance), and symbolizes a lot of what is ‘hot’ right now – E-Commerce and also it is Chinese (although it seems sentiment with China has been volatile of late).

Looking at the GMO forecasts one can see that they think US High Quality and Emerging Market equities offer the most promising seven-year returns. That to me is kind of the mirror image to what is currently hot (i.e. not US high quality! And BRIC/EM sales). Moreover, I would flag this – albeit dated – set of notes from a Seth Klarman speech at the Grant’s conference in October 2013 where Klarman notes big funds should be putting money into big blue chips (I take this to be roughly equivalent to GMO’s ‘US High Quality’ bucket).



So basically, with America high quality would be the way to go.

Meanwhile, Europe also shows a similar trend to the US in terms of stocks with EM exposure have underperformed with a performance bias towards the PIIGS and financial leverage, albeit nowhere to the degree that leverage has worked in the US. (Admittedly this is for peripheral Europe on reasonably well-deserved valuation and macro bounce factors – see Mark Yusko talking about it all in depth here)



Up until July European equities certainly seem to have been a reasonably consensus trade among institutional money, at least. (If one assumes ETFs tend to track institutional fund flows while mutual funds represent retail.) I guess one could argue that European equities then have some way to run as the retail money hasn’t got fully involved yet, although that reasoning (as opposed to valuation and MoS) is something of a greater fool line of thought TBH.




Now if one looks at trailing twelve-month ETF fund flows YTD then the Vanguard FTSE Europe ETF (VGK) has seen about $715mn in net inflows this year until end-July. HOWEVER, this actually masks a net 471mn outflow for July - the first time this year VGK saw a net monthly calendar outflow, and shortly after the Euro Stoxx 50 hit its YTD high in late June. So perhaps we are seeing some money starting to come off the table in Europe and a breakdown in the IPO market as some indication of a turning point? Or maybe it is just peeps unwinding positions going into les grand vacances? Who knows, but flows appear to have been very supportive of Europe so far this year I would observe.




So where is out-of-favor and could potentially represent good value?
Going back to the ETF fund flow data: Market Vectors Agribusiness has seen $2.6bn in outflows. This is quite incredible, as even GLD has finally managed to attract 263mn in inflows YTD! Now I am not sure if this means the underlying equities in MOO are cheap or not, but this probably warrants a look given pretty much every other asset class has seen net inflows YTD.

What about GEMs?
Flows and performance here has been interesting, while flows into DM has been solid and had been lifting markets there, GEM as a whole has performed remarkably well despite a large outflow of funds from the space. The table below is slightly old but you can see that EMs in general have suffered about a $20bn outflow, according to EFPR, while DM has seen about $86bn coming through the door as of mid-July.

Despite all this though the Vanguard EM ETF (VWO) is up 12% YTD; Europe (as represented by VGK) is flat  at -0.6% and SPY is up 6%.

Now the YTD outflows mask a turnaround in fortunes (at least as seen through ETFs) since Q2. A net $3.7bn outflow for VWO in Q1 swung to a net 1.3bn inflow in Q2 and a net $1.2bn came tumbling in through the gates in June alone.

That certainly suggests some change in sentiment to GEM on a broad basis is underway. Now how much value is there in the space left? CS releases a table of countries’ five-year average PBRs weekly in their Asian Daily note, culled from that and in order of biggest discounts below:

	Current P/B	5-year average	Discount
Brazil	1.5	1.6	-6.25%
Poland	1.3	1.4	-7.14%
Indonesia	3.6	3.9	-7.69%
Singapore	1.4	1.6	-12.50%
Korea	1.1	1.3	-15.38%
Colombia	1.6	1.9	-15.79%
Hungary	0.9	1.1	-18.18%
China	1.5	1.9	-21.05%
Chile	1.8	2.3	-21.74%
Czech	1.4	1.8	-22.22%
Morocco	2.7	3.8	-28.95%
Russia	0.7	1.0	-30.00%
Peru	2.3	3.5	-34.29%

As the table shows, the place is mainly full of central/eastern European, LatAm and AXJ names with Russia and Hungary the only two below book. GS research also shows a similar story of Sing, China, Korea and HK trading at the bottom of their 5-year PB bands. I would also note interestingly this table from the GS AXJ Kickstart last week.

Now I am not sure if global rates are going to go up but the Korean market is certainly cheap - check out Samsung, for example, and this would be an added bonus for Korean exposure.

Anyway, in conclusion, it looks like on a relative basis US High Quality/Blue Chips would be the place to go in DM; and in GEM value potentially exists in LatAm, parts of AXJ and central and eastern Europe.