What you need to know about Asia & Global price and earnings over the last 15 years
Updated: Jan 1, 2020
With the MSCI World Index and AC Asia Ex Japan index gaining over 23% and 10% respectively in 2019 despite “rumors” of recession “occurring” around soon, I have decided to run through the price and earning of the indexes to examine the fundamentals behind Global and Asia equities.
For those that are not familiar with the MSCI world index and AC Asia Ex Japan Indexes, it is basically a fund that captures large and mid-cap representation across specific regions.
The index covers approximately 85% of the free float-adjusted market capitalization in each country and hence is an instrument that seeks to mirror the performance of the underlying interests.
In this case:
world index seeks to mirror the performance of the world in general
AC Asia Ex Japan seeks to mirror the performance of the Asia region in general
For the scope of this analysis, we will be looking at the price in tandem with the earnings over the span of 15 years, from 2005 to 2019.
Note that this article should not be viewed as an analysis of current or forecast future global economic performance. Those require a different set of indicators – from which I will cover in other articles so do subscribe to the blog and not miss out on it.
Price to Earnings Trend
By applying the reversion to mean approach, I’ve indicated on the following graphs, the points of interception between the current P/E with the 3-year rolling average and cumulative average p/e values.
Intersection with 3 years rolling average are short-term indicators (circled)
Intersection with cumulative average are long-term indicators (Highlighted shades)
Here’s how you should interpret the insights from the chart:
Shaded in red: market being too optimistic
Shaded in green: market being too pessimistic
Circled in red: signs of potential overvaluation moving forward
Circled in green: signs of potential undervaluation moving forward
By examining the following charts, a few things are evident from the above charts:
World index is often traded above its accumulative average
Asia index is often traded below its accumulative average
Both Asia and World index are showing signs of overvaluation and market optimism in the last two years
To truly understand if this above trend is a cause for concern, we will now be examining the price movement relative to the earning performances.
Doing so should make things clear if the increase in price to earnings over the past 2 years is driven by speculation demand or organic growth in earnings.
MSCI World Index
For the past 10 years, the growth in the earnings of the world index can be considered a form of “recovery” back to the earning levels before the 2008 financial crisis.
However, in 2018 and 2019, there is a slowdown in the diluted earnings – probably due to events such as trade wars that impacted the earnings of global businesses.
In terms of actual growth, the compounded annual growth rate [CAGR] of the diluted earnings, between 2007 and 2019, stands at only 0.42%.
In terms of investment returns, not accounting for dividend returns, a lump sum investment in 2007 will yield only a CAGR of 2%, while a dollar-cost averaging approach will yield a CAGR of 6.57%.
Granted, if you were to invest a lump sum during the trough in 2008, your CAGR would have been 10.84% while a dollar-cost averaging approach will yield a CAGR of 7.34%.
But hey, if you know exactly when to buy at the lowest price and sell at the highest price let me know as well, I would love to invest with you.
All jokes aside, the point of this article is not to pin-point with precision, when to buy or sell, but rather to look at indicators and identify hints of over/undervaluation.
Overall, it is apparent that there has been a positive correlation between the price and earning trends from 2005 to 2017.
what is worrying is that from 2017 to 2019, despite a slowdown in the diluted earnings, the price of the world index continued to increase which is odd.
What this means is that in the past 2 years, the superb performance in investment return is mostly driven by speculative demand and is not backed by any fundamental improvements.
This deviation between the price and earnings is also observed in the Asia index.
MSCI AC Asia ex Japan Index
In terms of historical earnings, unlike the world’s index, Asia earnings have recovered and exceeded its peak earnings before the 2008 financial crisis from 2005 to 2019.
However, with recent developments, it is evident that the earnings in Asia have been badly impacted.
Currently, the earnings in 2019 stands close to the peak earnings in 2007.
In terms of actual growth, the compounded annual growth rate [CAGR] of the diluted earnings, between 2007 and 2019, stands at only 0.60%.
In terms of investment returns, not accounting for dividend returns, a lump sum investment in 2007 will yield only a CAGR of 0.19%, while a dollar-cost averaging approach will yield a CAGR of 3.40%.
If you were to invest a lump sum during the trough in 2008, your CAGR would have been 6.80% while a dollar-cost averaging approach will yield a CAGR of 3.96%.
Similar to the world’s index, is apparent that there has been a positive correlation between the price and earning trends from 2005 to 2017.
Also, despite a slowdown in the diluted earnings, the price of the Asia index continued to increase.
Due to the limitation of the use of Price and earnings as indicators, it is not possible for us to draw insights pertaining to future earnings (that will come in the other article) or why the market behaved in such an irregular manner.
The best insight that we have is on market sentiment at this current point in time is that:
Despite weakening fundamentals, the market is still relatively optimistic about the future prospect. Whether such optimism is founded or unfounded, any investor should be more cautious about the fundamental developments and determine if the price that they are paying for is worth the value that they are receiving.
In the short-run, minor deviation between the price and earnings is still tolerable.
However, in the long-run, if such deviation does not correct itself and instead worsens, it is a cause of concern as that is how “bubbles” are formed.
What you should take away from this article
Don’t try to time the market. Lump-sum investing requires more than just technical understanding but also access to relevant information to aid in your judgment and usually, such information is not easily accessible, especially for fund investing.
Personally, I will avoid any lump sum investment into any equity funds that are mirroring the world and Asia index at this given point in time as the market is showing signs of overvaluation despite weakening fundamentals.
For people who are currently invested in funds that mirror the world/Asia index performances, do pay more attention to future developments and adjust your portfolio allocation accordingly to avoid exposing yourself to too much risk.
For my clients who are investing with me, do know that I am watching this development closely and will be updating yall as time goes by. For now, the system and processes that we have in place are adequate and you need not fear the effects of major short-term fluctuation. If need be, we will adjust our portfolio allocation to adjust our risk exposure in the near future.
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Happy new year folks.
This article should by no means be seen as a buy/sell recommendation and is purely an opinionated article towards global equities as an investment instrument.
All information is extracted from the Bloomberg terminal and is hence subjected to the accuracy of the platform.
Results may be subjected to inaccuracies as the time period I am using is yearly and not monthly or weekly.
The analysis is subjected to the limitation of the indicators used