Breaking News
Get 40% Off 0
Is NVDA a 🟢 buy or 🔴 sell? Unlock Now

U.S., Germany And Japan: Post Brexit ETFs

By Cumberland Advisors (David Kotok)ETFsJun 24, 2016 10:05AM ET
www.investing.com/analysis/us,-germany,-japan:-post-brexit-200138031
U.S., Germany And Japan: Post Brexit ETFs
By Cumberland Advisors (David Kotok)   |  Jun 24, 2016 10:05AM ET
Saved. See Saved Items.
This article has already been saved in your Saved Items
 
 
META
+1.10%
Add to/Remove from Watchlist
Add to Watchlist
Add Position

Position added successfully to:

Please name your holdings portfolio
 
DCMYY
0.00%
Add to/Remove from Watchlist
Add to Watchlist
Add Position

Position added successfully to:

Please name your holdings portfolio
 
HMC
-1.12%
Add to/Remove from Watchlist
Add to Watchlist
Add Position

Position added successfully to:

Please name your holdings portfolio
 
SONY
-0.29%
Add to/Remove from Watchlist
Add to Watchlist
Add Position

Position added successfully to:

Please name your holdings portfolio
 
JNJ
+0.12%
Add to/Remove from Watchlist
Add to Watchlist
Add Position

Position added successfully to:

Please name your holdings portfolio
 
MUFG
+1.54%
Add to/Remove from Watchlist
Add to Watchlist
Add Position

Position added successfully to:

Please name your holdings portfolio
 

Before the Brexit vote and market turmoil, I was privileged to share interview time on the “The Larry Kudlow Show” with a longtime friend, Jeff Kleintop of Schwab. Larry, Jeff, and I have had many discussions about markets and economics over the years. In addition to discussing the pros and cons of Brexit, during this interview, I compared the valuations of three major markets: the United States, Japan, and Germany. For those who may have missed “The Larry Kudlow Show” on June 18, 2016, here is a recap. I am also including some explanatory notes. If you would like to listen to our conversation, you can find it here: our segment begins at the 58-minute mark.

The United States: SPY (NYSE:SPY)

The United States is the largest capital market and economy in the world. Its benchmark references the Standard & Poor’s 500 Index (S&P 500) and is represented by SPY, the first ETF, launched in 1993. It has been a remarkable success. With its low expense ratio, SPY captures the movement and activity of the S&P 500 within a few basis points (bps). The index itself is managed by State Street Global Advisors and represents large-capitalization stocks in the US. SPY has a market capitalization of about $180 billion, sees a very large trading volume every day, and usually trades within pennies of its net asset value.

Bloomberg data shows that SPY has had a trailing price-to-earnings (P/E) ratio of 24 over the last year. SPY shows 18 as its forward P/E estimate. Thus, the outlook for SPY is growth in earnings and an improving P/E ratio. Whether that outlook comes to pass remains to be seen. Improvement from an average P/E ratio of 24 to 18 is a positive indicator for the US economy and its profits.

Note that SPY is capitalization-weighted. The 10 largest weights are Apple (NASDAQ:AAPL) (2.88%), Microsoft (NASDAQ:MSFT) (2.21%), Exxon Mobil (NYSE:XOM) (2.09%), Johnson & Johnson (NYSE:JNJ) (1.76%), General Electric (NYSE:GE) (1.56%), Amazon.com (NASDAQ:AMZN) (1.52%), Berkshire Hathaway (NYSE:BRKa) (1.48%), Facebook (NASDAQ:FB) (1.45%), AT&T (NYSE:T) (1.39%) and JPMorgan Chase & Co. (NYSE:JPM) (1.27%). Those holdings drive a considerable portion of the index’s performance. If we do not consider the Google stock split (to form GOOG and GOOGL), then Alphabet (NASDAQ:GOOGL) is actually the second-largest holding (2.26%).

U.S. Valuation

For reference, we will note that pharmaceuticals constitutes about 7% and banks about 6.5% of the total index. The SPY yield is a little over 2%.

Given SPY’s 2% yield and outlook for a forward P/E ratio of 18, valuing SPY is a difficult task in a climate where the 10-year Treasury yield is about 1.5%. The earnings yield with a forward multiple of 18 is approximately 5.5%.

Thus, the equity risk-premium calculation would take the earnings yield (5.5%) and then subtract the 10-year Treasury yield. The difference is an equity risk premium of about 400 bps. In a climate of very low interest rates, low growth, puzzling monetary policy, and questionable robustness within the American economy, a 4% equity risk premium would suggest fair valuation and certainly not a bargain. The Brexit outcome suggests lower interest rates for a longer period with the Fed on hold for a while.

We are going to skip the world’s second-largest economy, China. Its markets are not liquid, deep, or qualified enough to rank among the mature economies or index-eligible global markets.

We are also going to skip the United Kingdom. Brexit issues have induced turmoil, so the calculation of valuation is set aside for the purpose of this writing.

We move forward with the other two major markets.

Japan: iShares MSCI Japan (NYSE:EWJ)

Japan is the world’s third largest economy and second largest mature equity market. It is represented by the iShares MSCI Japan ETF, EWJ, which captures the basic structure of the Japanese stock market. Within that structure, some sectors, such as pharmaceuticals and banks are quite comparable in size to those same sectors in the US. Pharmaceuticals are almost 7% in the Japanese market, as they are in the US. Banks are slightly over 7% in Japan, also similar to the United States. In other sectors, there are differences. For now, picking these two sectors provides a reference.

The largest holding in EWJ is Toyota Motor (5.09%) followed by Mitsubishi UFJ Financial Group (NYSE:MTU) (2.20%), KDDI Corp. (T:9433) (1.95%), SoftBank Group Corp. (OTC:SFTBY) (1.92%), Japan Tobacco Inc (T:2914) (1.60%), Honda Motor Company (NYSE:HMC) (1.54%), Sumitomo Mitsui Financial (NYSE:SMFG) (1.48%), Mizuho Financial Group (NYSE:MFG) (1.31%), NTT DOCOMO (NYSE:DCM (1.31%), and Sony (NYSE:SNE) (T:6758) (1.31%).

Japan Valuation

Japan (EWJ) shows an average trailing P/E ratio of 17. That ratio compares favorably with almost 24 for the United States. The Yahoo (NASDAQ:YHOO) Finance estimate of forward P/E is 14 for EWJ. Thus, the earnings yield for the Japanese ETF is estimated at 7%.

The interest-rate comparison for Japan is below zero. Post Brexit it is likely to stay below or at zero for many more years. The equity risk premium for Japan, using the riskless government bond interest rate, is higher than the earnings yield and above 700 bps. Truth be told, post-Brexit, there are questions about growth rates in Japan. But worst cases from Brexit are not as devastating as market panic selling has suggested. Japan was cheap before Brexit. The yield is 1.5% and is lower than the 2% in the US.

The list of companies, Sony and Toyota among them, illustrates how cheap Japanese stocks are, compared to US stocks. Their relative value is one reason why Cumberland Advisors’ international accounts continue to maintain an overweight position in the Japanese stock market. Japan’s is perhaps the cheapest major market in the world. EWJ is for sale at bargain-basement prices. It is historically rare for the equity risk premium to be higher than the earnings yield.

There are two possible reasons for this anomaly: (1) the market is fully mispricing outcomes in Japan, or (2) the market is offering investors a bargain that does not come along often. In our view, the right take is the latter, and for that reason we are overweight Japan.

EWJ has a market cap of approximately 15 billion and trades within pennies of net asset value. This holding is easy to execute for the US foreign investor.

Germany: EWG

The world’s fourth largest economy and third major market is Germany, which is represented by the iShares MSCI Germany ETF, (NYSE:EWG). The largest weights in EWG are Bayer AG (DE:BAYGN) (7.97%), Siemens AG (DE:SIEGn) (7.72%), SAP SE (DE:SAPG) (7.29%), BASF SE (DE:BASFN) (6.78%), Allianz (DE:ALVG) (6.52%), Daimler AG (DE:DAIGn) (5.88%), Deutsche Telekom AG (DE:DTEGn) (5.02%), Fresenius SE (DE:FREG) (2.78%), Muenchener Rueckver (OTC:MURGY) (2.75%) and Deutsche Post AG (DE:DPWGn) (2.68%). Here, just as in the other two ETF’s, we see a virtual “Who’s Who” of major global companies.

German Valuation

The yield in EWG is approximately 2.4% and is higher to that of SPY. The market cap is the smallest of these three at about $4 trillion. By the way, EWG trades in a liquid form and can be executed within a penny or two of net asset value. The trailing P/E average of EWG is 21, and the forward P/E estimate is 14, just as it is in Japan.

In Europe and in Germany, the 10-year reference for government debt is trading below zero. Brexit ensures it will be there for years. Hence, EWG has the same value characteristics as EWJ. We see this list of companies as cheap. The earnings yield for EWG is above 7%, as it is for EWJ in Japan. That equity risk premium is higher than the earnings yield because of the negative interest rate on the riskless government bond that it is compared to. Pharmaceuticals are 9.2% in the German basket, and banks are approximately 2.8%.

Our conclusion is that the United States, by metrics of valuation, relative valuation and comparison with riskless government debt, is fairly priced but no bargain. Japan and Germany, by comparison, are cheap. They offer bargains if investors are willing to test the waters. Companies like Toyota and Bayer or Siemens and Sumitomo are major players in the world. They rank as highly as many companies within the S&P 500 Index do. They are strong, heavily capitalized, globally active enterprises. In one place, they are available for an earnings yield above 7%.

by Cumberland Advisors

U.S., Germany And Japan: Post Brexit ETFs
 

Related Articles

TrackInsight
The Resurgence of Fixed Income ETFs By TrackInsight - Feb 22, 2024

Meta-description: Explore the remarkable recovery of fixed income ETFs in 2023, highlighting growth, market impact, and future prospects in the wake of a challenging year. The 2024...

U.S., Germany And Japan: Post Brexit ETFs

Add a Comment

Comment Guidelines

We encourage you to use comments to engage with other users, share your perspective and ask questions of authors and each other. However, in order to maintain the high level of discourse we’ve all come to value and expect, please keep the following criteria in mind:  

  •            Enrich the conversation, don’t trash it.

  •           Stay focused and on track. Only post material that’s relevant to the topic being discussed. 

  •           Be respectful. Even negative opinions can be framed positively and diplomatically. Avoid profanity, slander or personal attacks directed at an author or another user. Racism, sexism and other forms of discrimination will not be tolerated.

  • Use standard writing style. Include punctuation and upper and lower cases. Comments that are written in all caps and contain excessive use of symbols will be removed.
  • NOTE: Spam and/or promotional messages and comments containing links will be removed. Phone numbers, email addresses, links to personal or business websites, Skype/Telegram/WhatsApp etc. addresses (including links to groups) will also be removed; self-promotional material or business-related solicitations or PR (ie, contact me for signals/advice etc.), and/or any other comment that contains personal contact specifcs or advertising will be removed as well. In addition, any of the above-mentioned violations may result in suspension of your account.
  • Doxxing. We do not allow any sharing of private or personal contact or other information about any individual or organization. This will result in immediate suspension of the commentor and his or her account.
  • Don’t monopolize the conversation. We appreciate passion and conviction, but we also strongly believe in giving everyone a chance to air their point of view. Therefore, in addition to civil interaction, we expect commenters to offer their opinions succinctly and thoughtfully, but not so repeatedly that others are annoyed or offended. If we receive complaints about individuals who take over a thread or forum, we reserve the right to ban them from the site, without recourse.
  • Only English comments will be allowed.
  • Any comment you publish, together with your investing.com profile, will be public on investing.com and may be indexed and available through third party search engines, such as Google.

Perpetrators of spam or abuse will be deleted from the site and prohibited from future registration at Investing.com’s discretion.

Write your thoughts here
 
Are you sure you want to delete this chart?
 
Post
Post also to:
 
Replace the attached chart with a new chart ?
1000
Your ability to comment is currently suspended due to negative user reports. Your status will be reviewed by our moderators.
Please wait a minute before you try to comment again.
Thanks for your comment. Please note that all comments are pending until approved by our moderators. It may therefore take some time before it appears on our website.
 
Are you sure you want to delete this chart?
 
Post
 
Replace the attached chart with a new chart ?
1000
Your ability to comment is currently suspended due to negative user reports. Your status will be reviewed by our moderators.
Please wait a minute before you try to comment again.
Add Chart to Comment
Confirm Block

Are you sure you want to block %USER_NAME%?

By doing so, you and %USER_NAME% will not be able to see any of each other's Investing.com's posts.

%USER_NAME% was successfully added to your Block List

Since you’ve just unblocked this person, you must wait 48 hours before renewing the block.

Report this comment

I feel that this comment is:

Comment flagged

Thank You!

Your report has been sent to our moderators for review
Continue with Google
or
Sign up with Email