Meb Faber: Own The Most-Beaten-Down Stocks

April 08, 2014

ETF.com: How do you know for sure what you have in your hand is a value play—where it’s cheap and it shouldn’t be this cheap—versus a value trap?

Faber: That’s one reason we wanted to make sure to simulate in backtests what these portfolios would have looked like historically. The results are very clear that investing in cheap countries is a much better idea than investing in the broad market, especially in the expensive countries. That’s something a lot of people don’t focus on: It’s not just about investing in what’s cheap, it’s also avoiding what’s expensive.

A great example is Japan in the late ’80s. Japan was half the world’s market cap in the late ’80s. It was also, by far, the biggest bubble we’ve ever seen. They hit a CAPE of almost 100. If you were investing in an indexed broad global market portfolio, you had half your assets in the most expensive bubble we’ve ever seen. That’s not a smart thing to be doing, right?

It’s similar to where we find ourselves today. The U.S. is half the world market cap and it’s also one of the most expensive markets in the world. U.S. investors, which already have home-country bias, put 70 percent of their assets in U.S. stocks. From a value perspective, they should be putting less in the U.S.

It’s not just about buying what’s cheap, because any market could continue to go down even more. But it’s also about avoiding what’s expensive; and the reason you want a basket of these countries.

ETF.com: Is there an average time frame for how long it takes an overvalued or an undervalued market to go back to fair value?

Faber: A few charts in the book demonstrate this, and we looked at a lot of countries’ bubbles. I figured the number was around three years to work off some of the valuation.

But in Japan it took something like 17 years, the U.S. in late 1990s took about eight because it bottomed out in the ’08 bear market. So it depends. But it’s certainly, on the order of multiple years, somewhere between three to 10 depending on the magnitude of the bubble.

But that's why this fund only rebalances once a year. Anything under a year is not going to give the deep value stocks long enough to rebound in many cases.

ETF.com: The ETF portfolio right now is heavily allocated to Europe. What do you think is the most surprising country in there?

Faber: The headlines in Europe over the past few years have been consistently negative, both politically as well as economically. And that happens when markets are down and things are going poorly. But that’s when you want to be investing.

When you invest in these countries, the best returns can come from when things are horrific, and go from “horrific” to “not as bad,” to merely just “bad.” The Russia example is relevant. Everyone is hating Russia. It’s down a bunch this year; they’re doing very inflammatory things politically. But if things start to smooth out, you can see events unfolding, and you can see the market begin to rebound. The Russian stock market is already up about 15 percent from the bottom. You can have fairly explosive moves in these markets when things go from “terrible” to merely “not as bad.”

 

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