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TimingCube – The Simplicity of Investing

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Published December 29, 2017


There is a certain beauty to how we invest here at TimingCube. We buy the stock market or sell it. That’s all! With that approach we do not need to read any tea leaves regarding stock valuation, whether the Federal Reserve is going to ramp interest rates too fast or too slow, whether the economy will grow more or less than expected. We simply own the stock market when it is rising and sell it when it is falling.

We offer below what some other investors go through. This article from Schwab seeks to determine whether stocks are too expensive or not.

Too expensive to buy?
History says no. While valuation is important to long-term returns, there has been no consistent relationship between the price-to-earnings (PE) ratio (the price per share divided by the last 12 months of earnings per share) and stock market return over the next year, as you can see in the random scatter of dots for stocks around the world in the MSCI World Index in the chart below.
Nothing to see here: PEs and returns over the next year.

Are stocks too expensive to buy?

Source: Charles Schwab, MSCI World Index data from Factset as of 10/31/2017.

The current MSCI World Index PE ratio is 21.3. Since the inception of the MSCI World Index in 1969, a PE in the range of +/- 0.5 around 21.3 (20.8 to 21.8) has been followed by a total return of -5% to +45%, with an average return of +17.5%. Though valuations are above average – reflecting the better than average economic and earnings environment, there is no reason to believe stocks couldn’t go higher over the next year and even produce double-digit gains based on nearly 50 years of history, although of course history is no guarantee of future performance.

Are some markets expensive?
The global stock market may not be too expensive to rise, but what about the markets of different countries or regions – are some too expensive relative to others?

The U.S. has one of the highest PE ratios among countries or regions right now. Compared with the MSCI Euro Index, which tracks stocks in the 19 Eurozone countries, with a PE of 18, the U.S. looks pricey. Japan, at a PE of 15, looks like a real bargain. You can see the performance over the past decade and current PEs in the chart below.
Different performance, different valuations.

Are some markets expensive?

Indexes measure cumulative total return in U.S. dollars since start of 2006.
Source: Charles Schwab, MSCI data as of 10/31/2017.

Should investors favor Japan over the U.S. and Europe because it has a lower PE? We believe the answer is no, as all three of these markets are fairly valued relative to how they perform. We can see this when looking at the sectors that drive the performance of these markets.
The U.S. tends to behave like the global tech sector, as you can see in the chart below. So it isn’t surprising that the MSCI USA Index is valued like the MSCI World Information Technology Index, with a similar PE of 25. Strictly speaking, the U.S. stock market is composed of only about 20% tech stocks. So, in theory, the incredibly tight correlation of 0.99 between those two blue lines shouldn’t exist. But, in reality, it does. A bottom up weighting of the PEs of the stocks that make up the U.S. index misses the point of how the U.S. stock market actually behaves, and therefore, is valued.
Major stock markets are valued similarly to the sectors that drive their performance.

A closer look at sectors driving the markets.

Indexes measure cumulative total return in U.S. dollars since start of 2006.
Source: Charles Schwab, MSCI data as of 10/31/2017.

The Eurozone is composed of 19 European countries and tends to perform like – and is valued just like – a combination of three different world sectors: financials, telecommunications and materials. The MSCI Euro Index behaves like a mixture of .41x MSCI World Financials Index; .34x MSCI World Materials Index and .33x MSCI World Telecommunications Index. The weighted PE of those global sectors is 18, the same as the Euro index.

Let’s now look at Japan. The consumer discretionary sector is the largest sector of Japan’s stock market, which includes globally-recognized companies like Toyota and Sony. But the influence of financial conditions on all types of Japanese companies is evident in their performance which tracks the financial sector closely. Japan’s stock market is valued similarly to the MSCI World Financial Index at a PE of 15.

The takeaway from this comparison of countries and sectors is that the valuation differences between countries reflect how they perform and gives a very different investment conclusion from a simple comparison of the country PEs. Currently, these countries or regions do not appear materially over or undervalued relative to the sectors that they track. The sector PEs are all above average, but they are similarly valued relative to their 15 year histories. Each sector PE falls between 65% and 78% of that sector’s 15 year high.

Back here at TimingCube we are not concerned with valuation. Stock prices are moving higher. So we want to own stocks. When they stop moving higher, we will look to sell them. Regardless of P/E ratios, economic growth projections, the phase of the moon, or any other 2nd, 3rd, or 4th level metric. We focus on the price of stocks – the heart of the matter you might say. Those prices have thousands upon millions of assumptions factored in – all the P/E analysis, economic growth projections, et al. There is beauty in simplicity. Thanks to you all for joining us in this very profitable journey!

Market Update

Investors moved through the final week of an outstanding 2017 with little new information expected. Weakness in Apple (AAPL) on concerns over iPhone X demand was the only item of note in a lightly attended post-Christmas session Tuesday. The indexes closed off -0.1%. Wednesday saw that dip mostly recovered with a drop in Treasury bond yields the primary movement of the day. There was nothing of note to account for the drop in yields. Stocks opened higher but trended lower throughout Thursday to a +0.2% gain. Once more participation from investors was light and news sparse. Friday’s trading saw oil prices cross above $60 for the first time in two years as the U.S. dollar has resumed its decline this week. Stocks closed lower by -0.2% to bring a strong year to a close.

No Santa Claus rally this week as the S&P 500 (SPY) stuck close to the unchanged mark all week ending at a -0.02% return on the week. The Nasdaq 100 (QQQ) slipped -0.75% as the year’s market-leading index was hit by weakness in Apple as noted above. Small-cap stocks (IWM) were also flat on the week with a -0.08% result.

Warm wishes, Happy New Year! and until next week.