We have authored several articles on European market valuations. We discussed in particular Greece, where we mentioned that investors could gain exposure to through Global X FTSE Greece 20 ETF (NYSE:GREK), and Italy, where investors can purchase the iShares MSCI Italy Index (NYSE:EWI).
The countries with the lowest valuations obviously have the worst macro factors, and that is why Italian and Greek stocks are cheap. Global X FTSE Greece 20 ETF (NYSE:GREK) is down over 90% peak to trough, and iShares MSCI Italy Index (NYSE:EWI) is down over 70%. However, value usually wins in the end. In this article we explore some of the latest data on Europe and look at Russia in particular.
NOTE: The monthly valuation article for the US market will now be done on a quarterly basis. When the market has big swings we might do a short update. However, for now, the next update will be at the end of September.
Nomura has some good research out on European valuations. As usual, with sell-side research, we will ignore recommendations and focus on the data itself.
First a note and look at correlations: between Germany and various sectors in Russia:
“Stress test” the correlation between these trades, in August-October 2011 the correlation was also low at 0.14 and even during October-December 2008 the correlation of relative returns only rose to 0.22.
The average average correlation of the sectors in the chart below is only 0.17
In the long run (eg, for horizons out to the end of the year and beyond), attractive valuations are still the overwhelming feature of European equities. This stands in particular contrast to low levels of exogenous measures of risk, such as implied volatility.
This is evidenced in the chart below:
Nomura notes the following observation, which is slightly obvious, perhaps the defining feature of the current environment, is that it is one in which macro policy dominates.
The fit in Europe is especially close, with peaks in policy uncertainty in March 2003, January 2009, and November 2011, coinciding with peaks in the measure of the risk premium.
Russia, which is experiencing heavy outflows, looks cheap. Nomura notes that ‘from the previous peaks in outflows, in 2001, 2007 and 2009, the 6-month forward returns have always been positive, with an average of 43%,’ as shown in the chart below:
Retail investors can get exposure to Russian equities through Market Vector Russia ETF Trust (NYSE:RSX), which is heavily weighted towards Russian oil companies. 40% of Market Vector Russia ETF Trust (NYSE:RSX) consists of stocks from the Russian oil sector. SPDR S&P Emerging Europe (NYSE:GUR) is another ETF which gives investors exposure to Russia. However, SPDR S&P Emerging Europe (NYSE:GUR) still has a 39% allocation towards the oil sector, and Gazprom OAO (PINK:OGZPY) (FRA:GAZ) (MCX:GAZP), Russia’s largest oil company makes up 16% of SPDR S&P Emerging Europe (NYSE:GUR). Russia needs oil to average about $110 a barrel to balance its budget in 2012. However, the valuation is incredibly cheap.
Nomura has a very interesting statistic; At a 5.2 x 12 month forward P/E, Russia is the cheapest country in the MSCI world universe, trading even lower than Pakistan. Furthermore, Russian equities are very cheap, relative to European stocks.
Using a price to book ratio, Russian stocks trade at a 52% discount compared with Europe.
Finally, dividend yield.
Nomura notes; having historically been the country with the lowest dividend yield in the EEMEA universe, Russia’s dividend yield has almost doubled since April, through a 62% increase in the dividend level, and has moved to the middle of the range. At 3.7%, it is now close to the 4% level offered by developed Europe.
Nomura rightfully notes that besides the oil factor, politics are a major issue for Russian investors. Investors are spooked because of the authoritarian nature of the Vladmir Putin administration, but perhaps there has been an over-reaction on the part of investors. The entry to the WTO should be a positive for the country, and Vladimir Putin is trying to diversify the economy as much as possible. Furthermore, any increase in oil prices will be a big help for Russian equities.
In part II we look at the valuation of the German equity market.
Disclosure: The author of this article has a small position in both Market Vector Russia ETF Trust (NYSE:RSX) and Global X FTSE Greece 20 ETF (NYSE:GREK)