High valuations roughly correlate with lower expected returns, but even for value investors that can’t be the only the metric you look at as cheap is not the same thing as good value. Accounting for growth drivers and some limiting factors in addition to CAPE makes Sweden, Australia, the Netherlands, Switzerland and Taiwan the most attractive equities markets for the new year, argue JP Morgan analysts David Shairp and Patrik Schöwitz.

CAPE and dividend yields give conflicting growth predictions

“History suggests that at the cur­rent CAPE of 22.9x, real returns could average 3.2% per annum over the next decade, with a percentile rank of 88%,” they write. These returns are broadly in line with consensus estimates for 2014 equities growth, though it’s noticeable that historical returns show a steep drop in upside risk when valuations pass the 20x mark.

shiller PE ratios 0114 CAPE

The earnings model based on dividend yields (and buybacks, which have largely replaced dividends in some markets for tax purposes) paints a very different picture.

CAPE vs dividend yield 0114 CAPE

Following along with Arnott & Bernstein’s model from 2002, which uses current dividend yields, real dividend growth, and a market-specific dilution factor, suggests real average returns of 3.7% – 4.7% over the next decade, significantly stronger than what you would expect just from looking at CAPE. When both models along with price–to-book ratios are taken into account, the five countries with the most attractive valuations are Russia, Italy, China, Spain, and Brazil.

jpm valuation rankings 0114 CAPE

Depressed valuations are short-term opportunities

But these aren’t the markets that Shairp and Schöwitz actually recommend to investors, because they don’t believe those countries are well positioned for growth even if stocks are currently inexpensive. “While depressed valuations can throw up short-term opportunities, policymakers need to create a long-term growth dynamic and address growth constraints, if their markets are to produce superior long-term returns,” they write.

Ranking Equity markets CAPE

A lot of these factors are subjective, as Shairp and Schöwitz acknowledge, so the rankings should be taken with a grain of salt. Instead of being an investment guide, their ranking could be seen as a good starting point for stock picking strategies. Striking out countries like Russia (which has low valuations but also the lowest level of adherence to rule of law among listed countries, as measured by the World Justice Project) could be a good way for value investors to protect themselves from systemic risks as they evaluate companies in markets they aren’t completely familiar with.