After a turbulent May, are equities cheap?

Shaun Port


3 min read

A revival of trade tensions between the US and China unnerved investors and prompted selloffs in stock markets in May. Some equity investors suffered losses that offset or even exceeded the gains made during a rally in the first quarter. Though this is bad news for those who have lost money, some new investors might see this month as a chance to buy stocks at attractive prices. Are equities cheap? Let’s look at the evidence.

We assessed stock markets in 47 countries using data provided by MSCI, a compiler of financial information. Our process, which we have described in a previous blog post, combines several methods, both backward and forward-looking, for valuing a stock index. These measurements include: the price to book value, which shows the price of all stocks in a market or index (such as the FTSE 100) relative to the combined book value, or accounting value, of those stocks; the dividend yield, which is the proportion of the price that has been paid out as dividends; and the price-to-earnings ratio, which shows the price of the index relative to the total earnings over the past year. We also examine the forward price-to-earnings ratio, which compares the price against the consensus of expected earnings in the next 12 months. The last measure is important because traders often buy or sell equities based on their expectations for future earnings.

For each country, we put the current level of each metric in context by comparing it with the long-run average over at least 25 years and the deviation from the average. This allows us to derive a “normalised” value, known as a Z-score, for each metric. Then, to arrive at a single value to compare between countries, we combine the various Z-scores to get a composite score, displayed in the “weighted” column in the table below.

What do the numbers for May tell us? As usual, a score of zero represents the average, while +/-1 is expensive/cheap and +/-2 very expensive/cheap.

Across the globe

Source: Nutmeg calculations using data from MSCI, Macrobond. Long run refers to since 1994 for forward price-earnings, 1975 for trailing price-earnings and 1970 for price-to-book and dividend yield. Data history prior to 2001 is calculated using a combination of the Large and Mid size company indices. Z-Scores calculated as the number of standard deviations from the long-run average. The weighted Z-Score is calculated as a 50% weight to the forward p/e Z-score and 50% weight to the average of the three trailing measures.

May in numbers

The first thing to note is that, on a global basis, equities do indeed seem to be reasonably inexpensive, as of 31st May. The composite Z-score for developed world equities is -0.12 and the composite score for emerging market equities is -0.18. That means that, according to our analysis, both sets of equities are trading at below long-term valuations.

The effect is even more noticeable if we exclude the US, which, despite a sharp fall in equity prices during May, is still somewhat expensive according to our analysis. Leaving out the US, developed market equities had a composite Z-score of -0.68 at the end of May.

Some individual markets are especially inexpensive. The composite Z-score for Japan was -0.82 at the end of May while Austria’s was -0.98. The cheapest market in our list, according to our measurements, was Singapore, whose composite score was -1.24.

Costly markets

There were exceptions. Three of the five “BRICS”, a grouping of Brazil, Russia, India, China and South Africa that is sometimes used to represent the emerging market asset class as a whole, came out as expensively valued in our analysis. India, in particular, had a composite Z-score of 0.83. Russia and China appeared relatively cheap, however.

Elsewhere, the relatively small stock market of New Zealand appears highly expensive, according to our analysis. It had a composite score of 2.15.

What action to take

It is often said that every disaster is an opportunity. The stock market losses in May, while wiping value off investor portfolios around the world, have created an environment in which equities are attractively priced, relative to historical averages. Conventional wisdom suggests that now would be a good time to buy, but, as always, past performance is not a guide to future returns.

Risk warning

As with all investing, your capital is at risk. The value of your portfolio with Nutmeg can go down as well as up and you may get back less than you invest.  Past or future performance indicators are not a reliable indicator of future performance.

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Shaun Port

Shaun is the chief investment officer at Nutmeg. He has over 25 years’ experience developing and implementing investment strategies for clients ranging from central banks to pension schemes to charities and private individuals. Shaun holds a degree in Mathematical Economics from the University of Birmingham and is a Chartered Alternative Investment Analyst. He can be found tweeting @ShaunPort.


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