This page has been archived and commenting is disabled.

Guest Post: Madness... And Sanity

Tyler Durden's picture


Submitted by Tim Price via Sovereign Man blog,

“In investing, what is comfortable is rarely profitable.” — Robert Arnott

Valuations still matter.

Assuming that one is 'investing' as opposed to 'speculating', initial valuation (i.e. the price you pay for the investment) remains the single most important characteristic of whatever one elects to buy.

And at the risk of sounding like a broken record, “initial valuation” in the US stock market is at a level consistent with very disappointing subsequent returns, if the history of the last 130 years is any guide.

Without fail, every time the US market has traded on a cyclically-adjusted P/E (CAPE) ratio of 24 or higher over the past 130 years, it has been followed by a roughly 20 year bear market.

The evidence for the prosecution is clear, especially for the peak years 1901, 1929, 1966 and 2000. And 2013? The CAPE ratio is more than 25 today.

But there is the stock market, and then there are individual stocks. We have no interest in the former, but plenty of interest in the opportunity set of the latter.

We’re just not that interested in the US market, given general valuation concerns, and the malign role of Fed policy in distorting the prices of everything. As purists and unashamed value investors, we have plenty of other fish to fry.

Probably the biggest of those fish is that giant part of the world economy known as Asia. The chart below shows the anticipated growth in numbers of the middle class throughout the world over the next two decades.

AsiaGrowth Madness, and sanity

The solid green circle is the current middle class population (or as at 2009 to be precise); the wider blue-fringed circle represents the forecast size of this population in 20 years’ time.

The OECD definition of middle class is those households with daily per capita expenditures of between $10 and $100 in purchasing power parity terms.

Note that in the US and Europe, the size of the middle class is barely expected to change over the next two decades. The stand-out area is obvious: the emerging middle class in Asia is forecast to explode, from roughly 500 million to some 3 billion people.

In equity investing, the combination of a compelling secular growth story and compellingly attractive valuations is a very rare thing, the sort of investment opportunity that one might only see once or twice in a generation, if that.

But it exists, here in Asia, today. Once again, however, we have to abandon conventional financial thinking in order to exploit it.

Asian personal consumption between 2007 and 2012 – while the West was suffering from a little localised financial crisis – grew by 5% to 10% per annum. Industries likely to benefit from sustained growth in domestic consumption include food and beverages, clothes, cars, and insurance.

But the index composition of Asian equity index benchmarks leaves much to be desired.

Of the 10 largest companies in the MSCI Asia ex-Japan index, three are low margin exporters in Korea and Taiwan, one is a low margin Chinese telecoms business, three are state-run Chinese banks, one is an inefficient Chinese oil and gas producer, and one is an expensive Chinese internet business.

That doesn’t leave much for value investors to go on.

Asian equity funds more generally, tending to be index-trackers, are heavy in Chinese stocks of indeterminate value and clunky ‘old Asia’ exporters with far too much research coverage.

Or one can ignore index composition (‘yesterday’s winners’) entirely and focus instead on ‘best in breed’ businesses throughout the region on an unconstrained basis– especially those with favorable returns on equity, strong balance sheets, and low valuations.

As Greg Fisher of Adepa Asset Management wrote, amid a world of worries, “keeping the discipline of holding lowly valued, under-owned and unleveraged companies is likely to continue to protect our capital and earn us both income and capital appreciation over the longer term.”

Or to put it more plainly, and in the words of Warren Buffett, “price is what you pay; value is what you get.”

US stocks may be expensive, but you can get better economic fundamentals and cheaper valuations selectively throughout Asia.

And as insurance against the sort of disorderly currency moves that seem to be almost inevitable courtesy of so many central banks behaving badly, we still maintain you can’t do better over the medium term than gold.


- advertisements -

Comment viewing options

Select your preferred way to display the comments and click "Save settings" to activate your changes.
Mon, 11/25/2013 - 15:01 | 4188416 Trimmed Hedge
Trimmed Hedge's picture

Just gave myself a handjob..

Not gay, right?

Mon, 11/25/2013 - 15:20 | 4188478 RSloane
RSloane's picture

If historically investments into economies that were rapidly expanding their middle class with increased purchasing power were the 'smart' investments,  you can easily conclude, given the map, that investment in the US is risk on and investment in Asian economies is a much safer environment, even if speculatory in nature. The US has depended on the influx of foreign money in the past; this does not bode well for maintaining any sort of middle class with robust purchasing power in the future. Talk about the handwriting being on the wall. Very sad.

Mon, 11/25/2013 - 15:56 | 4188573 OutLookingIn
OutLookingIn's picture


First you have;

The super-rich, the 1/10th of 1% then you have;

The plain vanilla rich at the remainder of the 1% then comes;

Everyone else. The poor, the poorer and the poorest!

Mon, 11/25/2013 - 15:02 | 4188420 FieldingMellish
FieldingMellish's picture

Not worry. Just as always, its different this time.

Mon, 11/25/2013 - 15:04 | 4188423 texas sandman
texas sandman's picture

Enough of the finance crap, get back to bashing MaoBama and MaoBamaCare.


It makes for more entertaining snark.

Mon, 11/25/2013 - 15:13 | 4188464 RafterManFMJ
RafterManFMJ's picture

Someone needs to reference BitCoin.

Mon, 11/25/2013 - 15:06 | 4188435 JailBank
JailBank's picture

Bernanke has already proven you don't need a middle class to get all time market highs.

Mon, 11/25/2013 - 15:24 | 4188487 RSloane
RSloane's picture

He has absolutely proven that markets can achieve and maintain significant highs even while the middle class's purchasing power shrinks to an all-time low. Those two have been disconnected for so long that any improvement in the middle class quality of life is wholly accidental and irrelevant to the markets.

Mon, 11/25/2013 - 15:50 | 4188492 NoDebt
NoDebt's picture

Right.  And since China copies from us, do you think they now want what we've been working decades to get rid of- a middle class?  That annoying group of people who think they're allowed to make their own decisions and have the financial means to follow through on those decisions?

The graph above, sorry to say, is more than a tad Asia-optimistic.  If you think you're going to see 3 Billion middle class suddenly materialize in Asia by 2030 (with the obvious but unspoken implication being they will somehow save heavily-indebted western governments from their own insolvency) you're smoking crack.

Why do I feel like I'm being sold to here?

Mon, 11/25/2013 - 15:34 | 4188516 AbelCatalyst
AbelCatalyst's picture

I believe what is the outer circle in China will will be a tiny inner circle in the US when Bernellen is done destroying what remains of the middle class...  And I'm not sure a shrinking US middle class will have no impact on the growth in China...   

Mon, 11/25/2013 - 15:07 | 4188440 Stoploss
Stoploss's picture

Where's the bounce?? Er, recovery???

Mon, 11/25/2013 - 15:09 | 4188450 Son of Captain Nemo
Son of Captain Nemo's picture

On madness and sanity -this is unrelated but "related".

While the new deal with Iran was formally announced yesterday this i. the backdrop.

Beware of "purple lips" bearing gifts.


Mon, 11/25/2013 - 15:13 | 4188463 steveo77
steveo77's picture

Meteor and Comet Attack, TPTB will NOT warn you, they will lie even after the fact

Mon, 11/25/2013 - 15:14 | 4188466 Flounder
Flounder's picture

My quotron must be broken.  It says that TWTR just made a 52 week low today.  #BTFD

Mon, 11/25/2013 - 15:21 | 4188484 wagthetails
wagthetails's picture

I guess they forget that commodities (or simply just water) has put the inflation adjusted ceiling in on global growth. Global resources can't handle and 2.5bn middle class. Costs will just rise. At best stocks (after this madness) will only keep pace with inflation. Life is as good as it is going to get for a long time folks. And that is BEST case.

Mon, 11/25/2013 - 15:29 | 4188505 Dr Benway
Dr Benway's picture

The wave of wealth from the everincreasing Chinese middleclass will increase the price of this here asset I'm spruiking!


Guess the author hasn't read the countless articles on ZH about the debtfuelled nature of Chinese growth, or hasn't comprehended them in any case. When all those ghostcity property investments and local government projects blow up, wealth that has been created out of thin air disappears into thin air.

Mon, 11/25/2013 - 15:47 | 4188548 malek
malek's picture

So the North American middle class will only shrink be a few percent over the next 20 years?

I'd like some of what these guys are smoking.

Mon, 11/25/2013 - 16:02 | 4188593 BlackVoid
BlackVoid's picture

Totally unrelistic, there are not enough resources on the planet to support a middle class this size. Even the current system cannot be supported anymore.



Mon, 11/25/2013 - 16:18 | 4188642 Tall Tom
Tall Tom's picture

It just depends upon how you define "Middle Class". When the wealthy are defined as Middle Class the vast majority of Americans will be just totally impoverished.


Welcome to the United States...the youngest Third World Nation. That is the plan.


Go Bama. (...and some are not just talking about the Crimson Tide Football Team when they say this.)

Do NOT follow this link or you will be banned from the site!