Which stockmarkets look cheap after the torrid start to 2018?

Global stockmarkets have just suffered their first quarterly decline in two years. All major developed markets were in the red.

UK equities shed over 7% while Japan was down almost 5%. Even the previously untouchable US inflicted losses on investors.

Only emerging markets started the year with a spring in their step. Since the end of 2016, they have returned around 40% in US dollar terms, almost double the haul for developed markets over the same period.

As winter draws to a close in the northern hemisphere, households are engaging in their annual spring clean. Given recent market moves, now is a good time to do the same with your equity portfolio.

As we have argued previously, valuations can be a very useful tool when thinking about long-term investment strategy. They are next to useless at predicting short-term market movements but for the medium to longer term investor they are an essential part of the toolkit.

To continue the spring clean metaphor, redecorating your house to be constantly “on trend” is an expensive and time consuming task. Trends are so fickle that you may get it wrong anyway.

But valuations are like investing in classic design. The outcome may not always be flavour of the month but it is likely have a longer shelf-life than the latest fad.

Investors nursing losses from the first quarter of the year can draw some comfort that valuations are now looking less extended than three months ago. This suggests a more favourable environment for the long-term investor. However, we’re not out of the woods yet. Most markets, especially the dominant US (which is over 50% of major global equity benchmarks), continue to be expensively valued in at least some respects.

The table below shows a number of valuation indicators compared with their average (median) of the past 15 years, across five different regional equity markets. A description of each valuation indicator is provided at the end of this document. Figures are shown on a rounded basis and have been shaded dark red if they are more than 10% expensive compared with their 15-year average and dark green if more than 10% cheap, with paler shades for those in between.

The US continues to look very expensive on almost all measures. But a combination of positive economic momentum and fiscal stimulus could continue to support returns in the near term.

In contrast, Europe looks fairly valued. It is neither especially cheap nor expensive on any valuation indicator other than CAPE (explained below), which looks on the high side. However even here, the current CAPE is only in line with its 20-year or longer term average so this is not unduly concerning. When considered alongside the robust growth story in Europe, this market continues to have some appeal.

The UK is a mixed bag. Share prices look on the slightly expensive side, though not excessively so, when compared to earnings but cheap compared to book value or dividends. The UK’s high dividend yield has always been part of its appeal to some investors. Income of more than 4% clearly has its attractions in a low-yielding world.

However, a note of caution. UK-listed companies have been struggling to afford those dividends. They have been forced to pay out over two thirds of their recent earnings to do so, a much higher proportion than normal. Analysts are also forecasting the UK to have the worst prospects for dividend growth of all those in our analysis over the next two to three years. There may be value but it is not a time to be an indiscriminate buyer.

Emerging markets continue to look reasonably valued relative to developed markets but their strong performance has pushed prices up and the case is weaker than before.

Japan looks the most obvious buy from a valuation perspective but the export-oriented nature of the stockmarket means that it is also more exposed to the rising tide of protectionism and has a relatively weak outlook for earnings growth as a result.

So what would my valuation-based spring clean look like? It would suggest reallocating away from the US, in favour of emerging markets, Japan and Europe. If income is a priority then selective buying of the UK could also make sense. However, none of these are without risk. Markets that are cheaper are so for a reason. In these instances, maintaining a diversified exposure rather than betting it all on that daring new wallpaper you’ve been eyeing up should allow you to sleep more easily at night.

How to value stockmarkets

When considering equity valuations there are many different measures that investors can turn to. Each tells a different story. They all have their benefits and shortcomings so a rounded approach which takes into account their often-conflicting messages is the most likely to bear fruit. 

Forward P/E

A common valuation measure is the forward price-to-earnings multiple or forward P/E. We divide a stockmarket’s value or price by the aggregate earnings per share of all the companies over the next 12 months. A low number represents better value.

An obvious drawback is that no one knows what companies will earn in future. Analysts try to estimate this but frequently get it wrong, largely overestimating and making shares seem cheaper than they really are.

Trailing P/E 

This is perhaps an even more common measure. It works similarly to forward P/E but takes the past 12 months’ earnings instead. In contrast to the forward P/E this involves no forecasting. However, the past 12 months may also give a misleading picture.

This is particularly true if earnings have slumped but are expected to rebound. For example, UK equities are very expensive on this measure at present, partly because of past commodity price declines and the UK market’s large commodity exposure.

However, commodity prices have rebounded amid an expectation of a profit rise this year. The UK therefore looks very expensive on a trailing P/E basis but less so on a forward P/E basis.


The cyclically-adjusted price to earnings multiple is another key indicator followed by market watchers, and increasingly so in recent years. It is commonly known as CAPE for short or the Shiller P/E, in deference to the academic who first popularised it, Professor Robert Shiller.

This attempts to overcome the sensitivity that the trailing P/E has to the last 12 month’s earnings by instead comparing the price with average earnings over the past 10 years, with those profits adjusted for inflation. This smooths out short-term fluctuations in earnings.

When the Shiller P/E is high, subsequent long term returns are typically poor. One drawback is that it is a dreadful predictor of turning points in markets. The US has been expensively valued on this basis for many years but that has not been any hindrance to it becoming ever more expensive.


The price-to-book multiple compares the price with the book value or net asset value of the stockmarket. A high value means a company is expensive relative to the value of assets expressed in its accounts. This could be because higher growth is expected in future.

A low value suggests that the market is valuing it at little more (or possibly even less, if the number is below one) than its accounting value. This link with the underlying asset value of the business is one reason why this approach has been popular with investors most focused on valuation, known as value investors.

However, for technology companies or companies in the services sector, which have little in the way of physical assets, it is largely meaningless. Also, differences in accounting standards can lead to significant variations around the world.

Dividend yield 

The dividend yield, the income paid to investors as a percentage of the price, has been a useful tool to predict future returns.

A low yield has been associated with poorer future returns.

However, while this measure still has some use, it has come unstuck over recent decades.

One reason is that “share buybacks” have become an increasingly popular means for companies to return cash to shareholders, as opposed to paying dividends (buying back shares helps push up the share price).

This trend has been most obvious in the US but has also been seen elsewhere. In addition, it fails to account for the large number of high-growth companies that either pay no dividend or a low dividend, instead preferring to re-invest surplus cash in the business to finance future growth.

A few general rules

Investors should beware the temptation to simply compare a valuation metric for one region with that of another. Differences in accounting standards and the makeup of different stockmarkets mean that some always trade on more expensive valuations than others.

For example, technology stocks are more expensive than some other sectors because of their relatively high growth prospects. A market with sizeable exposure to the technology sector, such as the US, will therefore trade on a more expensive valuation than somewhere like Europe. When assessing value across markets, we need to set a level playing field to overcome this issue.

One way to do this is to assess if each market is more expensive or cheaper than it has been historically.

Finally, investors should always be mindful that past performance and historic market patterns are not a reliable guide to the future.

How do today’s valuations compare to May 2017? Find out here: How cheap are world stockmarkets? Five key tests

Duncan Lamont

Head of Research and Analytics


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Data Breaches & Cryptoworms: The World Held to Ransomware

Technology stocks shuddered Monday, following the New York Times expose of a politically aligned insights group harvesting the data of 50 million Facebook users. While raising fears of regulatory intervention in big tech, this demonstrates how data security and cyber risk need to be front of mind for companies, governments and investors. Over the past few years, an escalating and increasingly concerning spate of data breaches and hackings has come to light, providing genuine cause for concern.

In June of 2017, reports of companies falling ill to new hijacking software began filtering through news agencies. Cyber Security firm, Kaspersky, was reporting wide ranging infections of a new malware variant causing material damage to organisations.  The severity of this wave of “ransomware” became more apparent as it spread from little known Ukrainian banks to large Western corporations. This malicious software, dubbed NotPetya, followed hot on the heels of the less damaging, but highly pervasive, WannaCry outbreak.  The gravity and economic impact of this event only became quantified as global listed companies began reporting the quarterly earnings impact of losing access to their data and systems for several days. Maersk, hit so severely that internal communication devolved to WhatsApp messaging, announced a financial impact of US$300m on its third quarter earnings.  FMCG behemoth Reckitt Benckiser, the U.K based manufacturer of household brands like Dettol, acknowledged the incident would reduce like-for-like sales from 3% to 2%, or around £100m, owing to supply chain disruptions and manufacturing down time. Many other listed corporations including FedEx, Merc and WPP joined the chorus of downgrades, and these were just the businesses that were required to under statutory reporting laws. Countless companies were spared the reputational damage of confessing their security breach.

The NotPetya catastrophe was an example of a Cryptoworm, designed to encrypt data and storage devices, then demand Bitcoin payments to unlock them.  Malicious software is a continuously evolving beast, driven by a cat and mouse game between hackers, security firms and governments.  A fortuitous development for this illicit craft was the onset of cryptocurrencies, allowing anonymous transfers of digital ransom.  Even paying the ransom may not save your data, as the intent of the malware is often to merely inflict damage. NotPetya’s ability to harvest ransom was also limited as the email address used to receive decryption keys was quickly shutdown by its ISP. The likely resolution in most cases was for I.T staff to simply restore systems to backup images and attempt to resurrect systems to an operating state.

Viruses have plagued organisations for as long as computers have enabled data to be transferred.  Corporate history is littered with incidents of enterprises crippled by nefarious code targeting key systems. Perhaps the most prolific worldwide infection was the Slammer worm in 2003, which managed to exploit Microsoft SQL databases all over the world. The result was to crash servers, drain network resources and in the process slow the entire World Wide Web. While frustrating and time consuming to eradicate, this generation of viruses lacked the audacious economic and often political motives featured in contemporary ransomware.

As devastating and operationally disruptive ransomware attacks can be, they often pale in comparison to the reputational damage inflicted when customer data is stolen, rather than destroyed. This form of attack has become a favourite of the hacker community, where network vulnerabilities are exploited, and sensitive customer data held for ransom.  A well-publicised case occurred October 2016 when Uber’s databases were breached and the records of 60 million riders and 7 million drivers lifted.  While the company paid a US$100,000 ransom to maintain discretion, it later moved to disclose the event.

In 2017, U.S credit bureau Equifax suffered what was likely the most damaging hack in U.S corporate history. More than 140 million citizens had their most sensitive of personal data, including demographic and credit card numbers, stolen from the company’s servers. The hacker’s demand for a US$2.6m ransom was not forthcoming but related costs, fines and class actions are likely to be several hundred million.

Simultaneously terrifying and hilarious was the case of dating site Ashley Madison. After gigabytes of user data was copied from their servers, the hackers made public the names and email addresses of subscribers. Good Samaritan internet vigilantes quickly made the information easily searchable online, resulting in much consternation for philanderers worldwide. The websites owner, Avid Life Media, ended up settling a user class action for $11.2m.

A more complex development was the discovery of two vulnerabilities in common microprocessors, dubbed Meltdown and Spectre, earlier this year. Academics discovered it was theoretically possible for data to “leak” from one computer process to another whilst running on the same machine.  While concerning for personal devices, the real danger is to cloud computing services, including AWS and Google Cloud, where multiple organisations run independently on the same hardware platform.  Under this cost effective and efficient form of socialised computing, customers have processes separated into virtual “instances” but the shared physical processing may open up potential vulnerabilities. Chip makers and software providers quickly released patches for the susceptibilities, yet decades worth of PC’s and servers manufactured with the bug left millions of machines potentially still exploitable.

In Australia, digital intrusions have been less high profile but still concerning. Car sharing network GoGet admitted to having consumer data accessed by a hacker who used the information to steal vehicle access. A 2011 incident involved daily deals website Catch of the Day, where stolen personal information and credit card numbers were not reported to customers nor the police for over three years. Since then, Australia’s laws governing the theft of consumer data have come up to date with most western economies. As of February 2018, the Privacy Amendment (Notifiable Data Breaches) Act 2017, requires the prompt notification of data breaches, and applies to companies with annual revenue in excess of $3 million a year.  All of these incidents have become a lightning rod for corporations to assess their information security regimes. A spate of class actions now sees cyber security firmly entrenched in the ESG (Environment, Social Governance) lexicon, requiring boards to clearly formulate strategies to protect their data and the privacy of their customers.

The array of threats to individuals and organisations from data destruction and theft has evolved alongside a burgeoning digital security industry. Today’s technology industry relies on companies offering hardware and software solutions to protect us from the digital barbarians threatening our security and privacy. Aside from exorbitant fees extracted by I.T security consultants, a number of investment themes take advantage of this necessary obsession with data fidelity. One such company, F5 Networks, is included in our Global Growth portfolio.

F5 specialises in communications equipment, targeted at the Application Delivery Controller (ADC) market. Based in Seattle in the U.S, the company’s products help secure the applications and websites of service providers, corporate and government customers around the world.  The group benefits from the exponential growth in data flow, driven by trends including cloud computing, streaming video and online retail. Whilst the firm was only incorporated in 1996, the company has grown into a USD2bn  revenue business with a strong growth and profitability profile.

Sam Stobart 
Head of Distribution
Arnhem Investment Management