Monday, September 26, 2016

A Common Sense Valuation Comparison of Global Equity Markets

A Common Sense Valuation Comparison of Global Equity Markets
* and the relevance for quantitative (algorithmic) Mean Reversion startegies

# click on image to see bigger Table


Table 1: Worksheet


Table 2: Earnings-based



Table 3: Dividends-based
  • ·         Each country’s financial markets have their own characteristics and peculiarities so comparing them with a global average of Price/Earnings, Price/Book etc  is meaningful.
  • ·         Because of the loose money policy (Quantitative Easing) by the major economies (Eurozone, USA, Japan, even China in some ways) in the recent years, leading to low interest rates, there is a tendency for financial asset bubbles to arise, caused by excess funds chasing yields.
  • ·         The interplay between the Bond market and Equity market is an often underrated  factor in determining the direction of the equity index.
  • ·         Different kinds of analysis are more relevant depending on the current mode and mood of the market viz recessionary vs inflationary times, low growth vs high growth, risk-on vs risk-off mode.
  • ·         In the current low-growth environment, the Dividend factor is more important than the Earnings factor.
  • ·         Instead of Price/Earnings I have used Robert Schiller’s (the man who ‘predicted’ the 2008 US sub-prime mortgage crisis) CAPE (Cyclical Adjusted Price Earnings) which uses moving averages of 10-year earnings adjusted for inflation
  • ·         Unlike Momentum strategies, Mean Reversion strategies MUST be underpinned by Fundamentals. This is especially so in Index Futures which are based on expectations not historical.
  • ·         For Index Futures traders using a Mean Reversion strategy, Dividend Yield/10year-Bond Yield Spread is a better indicator of mid-term reversion to the Mean than the CAPE-10 year Bond Yield Spread.
  • ·         Going by Dividend factor as in Table 3 France, UK and Australia are top three undervalued, instead of China, Singapore and India if we go  by Price/Earnings factor as in Table 2.
  • ·         However, this analysis is just one variable in a quantitative model of global equities and output like direction will depend on degree of cointegration among the various markets


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