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Why the current market order may not last much longer
Investment frenzies usually have a limited shelf life, and the current trend has been in progress for more than nine years

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Saturday, June 9, 2018 – Page B12

Folks, this is getting ridiculous.

Since the financial crisis, investors have gone all in on three big bets. They've gambled that the U.S. recovery will continue to lead the world, that technology companies will be the big winners in the new economy and that growth will be worth more than value. People who bet on these notions have left their peers in the dust.

At this point, though, it's worth asking if our collective obsession with this three-pack of trends isn't just a bit overdone.

Investment frenzies usually have a limited shelf life, and for good reason. Once people catch on to a trend, they tend to bid it up to unsustainable levels, leading to an inevitable decline.

Back in the 1990s, for instance, the dot-com bubble spanned roughly seven years before collapsing. In the early 2000s, commodities burned red hot for around six years before running into the big chill of the financial crisis.

In contrast, the current market trends have been in progress for more than nine years. As investing themes go, they're getting positively geriatric.

Could market leadership shift over the next year or two? At the moment, there's little indication such a change is in the offing.

However, sentiments can shift dramatically and faster than you think. Remember how we were all worked up about peak oil back in 2006? That now looks rather quaint.

One factor that threatens the current market order is the gap in valuations between the big winners and the runners-up. Stocks with today's magic ingredients are far more expensive than their less fortunate counterparts.

Let's explore just how wide that gap has grown.


If you had told someone in the depths of the financial crisis that the best place to invest over the next decade would be the United States, it would have seemed an odd notion. Wall Street, after all, was where the crisis began. Sliding U.S. home prices seemed sure to weigh on growth for years.

Yet the United States has been the runaway winner in recent years among global stock markets. Over the past nine years, investors would have enjoyed a 256-per-cent total return by simply buying the S&P 500 index of big U.S. stocks.

In contrast, they would have received only a 102-per-cent total return by investing in an index that tracked the rest of the world.

For that matter, a Canadian investor who stuck to Canadian stocks would have derived only a 70-per-cent payoff. (All results calculated in U.S. dollars and include reinvested dividends.)

The difference in returns has opened up a wide gap in valuations, especially if you measure things by looking at current stock prices in relation to average corporate earnings over the past decade.

This cyclically adjusted priceto-earnings ratio, or CAPE, stands at a lofty 29.8 in the United States.

That is its highest level since the dot-com bubble. In contrast, Canadian stocks have a CAPE of 21.0 while German stocks are at 20.2 and Chinese stocks are at 18.3.

Other valuation measures, such as price-to-book ratios and price-to-sales ratios, show a similar gap between U.S. stocks and their international counterparts.

By all these measures, U.S. stocks are far pricier than their global rivals.

None of this means that stocks in the rest of the world will suddenly surge or that U.S. stocks will take a tumble. But it is difficult to see why stocks should permanently remain that much more valuable in the United States than elsewhere in the world.


If you know a value investor, give him a hug. The past few years have been rough for folks who like to buy cheap stocks in hopes they will rebound. In contrast, the recent patch has been a wonderful time for people who bet on fast-growing stocks in hopes they will keep going up.

One way to measure the gap is to look at the difference between the MSCI World Value Index and the MSCI World Growth index.

Each index includes large and mid-sized stocks from 23 developed countries selected for either their value or growth characteristics. Over the past nine years, the growth index has achieved a total return of 205 per cent. The value index has returned only 148 per cent.

This is not the usual course of events. Since 1974, the value index has substantially outperformed the growth index, even factoring in its slump of the past decade.

It's anyone's guess when or if value will return to its usual winning ways, but one thing is sure: The value contingent provides far more bang per buck than its growth counterpart. The average price-to-earnings ratio of stocks in the MSCI value index hovers around 15, while the equivalent figure for the growth index is 25.


Of course, one of the driving forces behind the superb performance of both U.S. stocks and growth stocks has been the sizzling results of a handful of big tech companies.

Many of the biggest successes are U.S.-based businesses, such as Alphabet Inc., Facebook Inc., Netflix Inc., Inc. and Apple Inc. But don't forget the Asian superstars, such as Samsung Electronics Co. Ltd. of South Korea or Tencent Holdings Ltd.

and Alibaba Group Holding Ltd. of China.

The successes of these tech giants have overwhelmed other sectors. Since 2009, the iShares Global Tech ETF has returned 314 per cent, while similar funds spanning global materials companies and global consumer staples producers have generated only 74 per cent and 150 per cent payoffs, respectively.

As a result, the companies in the tech ETF now have an average P/E ratio of nearly 29, compared with 18 for the materials companies and 16 for the consumer staples giants. Those valuation gaps may be justified by the rapidly expanding profit at the tech giants. But if tech profit stumbles at all - perhaps because of tighter rules about how personal data is used? - a correction is in order.


Bets on U.S. stocks, growth stocks and tech stocks have all produced rich results for investors over the past nine years. There's no sign of those trends flagging - indeed, the past few months have seen them continue to outperform broader markets.

However, the valuation gaps that have opened up are dramatic. Investors should remember it's difficult to make big profit by buying already expensive stocks.

In contrast, now looks like a fine time to explore the less loved corners of the market.

Huh? How did I get here?
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