Why British Stocks Are Set To Trounce U.S. Shares
Plenty of investors are like dogs chasing tails. They might say, "I’m going to buy this investment because it’s performing well." This, however, is as crazy as a talking poodle. When we talk about investing, we can’t use present tense. It doesn’t exist. We can only see the past. When an investor says, "This is performing well," what they really mean is, "This has performed well."
Packs of tail-chasers are in love with U.S. stocks. It’s easy to see why. Over the 12 months ending November 29th, 2019, the S&P 500 gained almost 28 percent. Over the past ten years, it soared 250 percent. And that’s measured in U.S. dollars. Over the past decade, the U.S. dollar beat the British pound and the Euro. When measured in British pounds, the S&P 500 gained 278 percent. When measured in Euros, it gained 286 percent.
This is more than enough to make Pavlov’s dogs drool. But we shouldn’t invest like canines. To provide context, Robert Shiller created something called a CAPE ratio. It’s the closest thing we have to a working crystal ball. Based on Shiller’s measurement, U.S. stocks might be among the world’s worst performers over the next ten years. Investors chasing past performance might bite their own tails.
This might be hard to imagine (particularly for the Brexit crowd) but UK stocks should leave U.S. stocks behind.
Let me explain. Robert Shiller is a Nobel-prize winning economist. He created the cyclically-adjusted-price-to-earnings (CAPE) ratio to compare stock prices to business earnings. It might sound like a typical price-to-earnings (PE) ratio. But it’s a stricter measurement. A PE ratio only measures current stock prices compared to the previous year’s business earnings. An unusually stellar or dismal business year could make the reading look silly.
CAPE ratios are different. They compare current stock prices with average inflation-adjusted earnings over the previous ten years. Shiller found that when CAPE ratios are well-above historical averages, stocks disappoint investors over the following ten years. In contrast, when CAPE ratios are far below their historical average, the decade ahead almost always ends up great. U.S. stocks might look like fluid climbers scaling a massive cliff. But based on Shiller’s measurement, they’re bleeding from the ears. Their CAPE ratio is now 30 times earnings. That compares with a historical average of about 16.8 times earnings. U.S. stocks have only been this expensive twice before: in 1929 and 2000. Stocks dropped heavily from 1929-1932. They also fell hard from 2000-2002.
This doesn’t mean U.S. stocks will plummet once again. They might keep rising for a few more years…and then fall hard. They might stagnate for a decade, or climb up and down like a drunkard on a rope. But based on Shiller’s research, it doesn’t look great.
By comparison, UK stocks are cheap. According to StarCapital, UK stocks trade at a CAPE ratio of about 15.8 times earnings. That’s roughly aligned with the market’s long-term average. They aren’t trading at a fireside sale. But they’re still far cheaper than stocks in most other markets. That’s the silver lining behind the Brexit fears.
Unfortunately, plenty of Europeans are avoiding UK stocks. They’ve sought ETFs that don’t include UK shares. This includes the iShares MSCI Europe ex-UK UCITS ETF (IEUX). But bypassing Britain could be a big mistake. After all, British shares are cheaper than the rest of developed Europe…and this could benefit the patient.
Don’t, however, ditch U.S. shares to load up on UK stocks. Smart investors build globally diversified portfolios of low-cost ETFs.
British investors could build a portfolio that includes Vanguard’s UK FTSE 100 Stock Index (VUKE). It includes Britain’s biggest stocks. It charges a paltry 0.09 percent per year. If investors want to add some smaller stock exposure, they could include Vanguard’s UK FTSE 250 Index (VMID). Its management fees are just 0.10 percent.
Global stock exposure would diversify the portfolio further. Investors could buy Vanguard’s FTSE All-World ETF (VWRL). It charges 0.22 percent per year. Roughly half of this index includes U.S. shares, with the remainder allocated to the rest of the world.
If you’re worried about Brexit, you aren’t alone. But beware of short-term thinking. Nobody knows what the next few years will bring. Shiller’s CAPE ratio, however, points to British stocks trouncing U.S. shares. It doesn’t predict how these stocks will perform over the next few years. But it’s uncannily correct when looking forward ten years.
British Portfolio Models Taking Advantage Of The CAPE
Source: Millionaire Expat, How To Build Wealth Living Overseas (Wiley 2018)
Andrew Hallam is a Digital Nomad. He’s the author of the bestseller, Millionaire Teacher and Millionaire Expat: How To Build Wealth Living Overseas
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Please note the value of investments can go down as well as up, and you may not get back all the money that you invest. Past performance is no guarantee of future results.