Why 2017 was a Lousy Year for U.S. Stocks

I bet you think the U.S. stock market had a banner year in 2017.

After all, the S&P 500 closed the year with a 19.4% gain to mark the best return since 2013. I’m here to tell you why you are wrong.

On the global stage, the performance of U.S. stocks in 2017 was downright mediocre.

Meanwhile, the U.S. stock market is as overvalued as it has been in decades. So, ignore the mainstream media debates on whether the U.S. stock market can replicate 2017’s 20%+ run.

Instead, turn your investment gaze to global stock markets. I’m betting that’s where the money is in 2018.

Where the U.S. Stock Market Stands Today

The U.S. stock market has had a remarkable run over the past decade. Among the 47 global stock markets I monitor, the U.S. stock market, as measured by Vanguard Total Stock Market ETF (VTI), still ranks 1st over 10 years.

In fact, VTI, and the U.S. stock market it represents, ranks within the top 10 for the past three- and five-year periods as well. But 2017 showed the first cracks in the U.S. stock market’s longtime dominance.

On the one hand, the U.S. stock market had a banner year in 2017, with VTI closing the year up 21.21%.

On the other hand, compared to global stock markets, VTI’s run is much less impressive. In fact, the U.S. market ranked a lowly 39th out of 47.

That may be the U.S. stock market’s worst relative performance in the last 10 years.

U.S. Stock Markets: An Overvalued Underperformer

I believe that the U.S. stock market’s underperformance comes back to valuation.

Germany’s Star Capital tracks global stock market valuations based on a wide range of valuation measures, including price-to-earnings (P/E), price-to-book (P/B) and the Cyclically Adjusted Price to Earnings (CAPE) ratio.

Here is a quick review of some of the measures Star Capital looks at…

The P/E ratio, of course, is the most commonly used measure of value. You just take the share price and divide it by the annual earnings-per-share figure. The lower the P/E ratio is, the better the value.

The price-to-book ratio, or P/B, looks at how a company’s market value compares with the current value of its assets (e.g., real estate, buildings, machinery and intellectual assets, etc.). For investors, the lower the better.

The cyclically adjusted P/E (commonly known as the CAPE ratio) measures the current price of a market divided by the average of 10 years of earnings adjusted for inflation. Popularized by Yale Nobel-Prize-winning laureate Robert Shiller, the CAPE is like a long-term price-to-earnings (P/E) ratio.

Based on these measures, Star Capital has terrible news for investors in U.S. stocks.

With a P/E ratio of 22.4, a CAPE ratio of 29 and a P/B of 3.1, the U.S. stock market is hugely overvalued when compared to its historical averages.  

In fact, the U.S. stock market is the third-most-overvalued one on the planet when compared to 43 major global stock markets in Star Capital’s universe.

Only the stock markets of tiny Ireland and Denmark are more expensive than the U.S. market.

So, What’s Cheap in the World?

Let’s take a look at the stocks on the other end of the valuation spectrum.

According to Star Capital, the cheapest market in the world right now is Russia.

It scores an 8 P/E ratio, a 5.6 CAPE ratio and a 0.8 P/B ratio.

That’s no surprise. Russia has always been the market investors love to hate. In 2017, 46 of the 47 global stock markets I track recorded double-digit-percentage gains.

The much-reviled VanEck Vectors Russia ETF (RSX) was the only market that ended 2017 up by only single-digit percentages. The other two cheapest stock markets on Star Capital’s list include Turkey and Brazil.

Unlike Russia, both had a banner year.

iShares MSCI Turkey ETF (TUR) soared 37.62%.

The iShares MSCI Brazil Capped ETF (EWZ) rose by 23.66%.

The strong performance of the world’s cheapest markets (outside of Russia) suggests that the smart money has started to recognize the value in global markets.

That’s also why Russia is likely to be one of 2018’s top performers.

Why Global Stock Markets Will Dominate in 2018

Emerging market stocks trounced their U.S. counterparts in 2017.

The MSCI Emerging Markets Index ETF (EEM) soared 37.28% compared to the 21.70% gain for SPDR S&P 500 ETF (SPY).

I believe that this outperformance of global stocks has just started.

Here’s why…

First, I’ve already touched on the topic of valuation.

U.S. stocks are as expensive relative to the rest of the world as they have ever been on a CAPE ratio basis.

Such a vast divergence tells you a lot about expected future returns.

In the United States, you can expect to earn about 4% real returns per year over the next decade.

In emerging markets, you can expect twice that amount — 8%.

Second, like everything else in life, stock markets have their seasons.

The U.S. stock market has been “in season” for the past decade.

The average annual return of the SPDR S&P 500 ETF (SPY) over the past decade has been 8.43%.

In contrast, the MSCI Emerging Markets Index ETF (EEM) has returned a meager 1.39% per year.

The U.S. stock market’s dominance is already waning, as global stock markets trounced the United States in a big way in 2017.

The only surprising thing is that investors don’t seem to have noticed.

So what’s my favorite way to invest in global stock markets?

The Cambria Global Value ETF (GVAL) invests purely based on my preferred measure — the CAPE ratio. Chock full of some of the world’s most hated and obscure stock markets, GVAL is not an easy position to invest in.

The ETF’s top five country holdings are Austria, Portugal, Russia, Greece and Spain.

These are some of the cheapest markets in the world. Austria and Portugal were among the world’s top performers in 2017, as well.

As global investment pioneer Sir John Templeton observed:

“People are always asking me where the outlook is good, but that’s the wrong question. The right question is: ‘Where is the outlook most miserable?’”

Cambria Global Value ETF (GVAL) offers you an easy way to follow Sir John Templeton’s advice.