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Interesting Article: Hold Your Nose and Buy Europe

Jason Zweig wrote an interesting article in the May 28th Wall Street Journal entitled, “Hold Your Nose and Buy Europe.”  Zweig says that as investors search for bargains in a world of overpriced assets, they should be guided by the EMH. That isn’t the Efficient Market Hypothesis, which holds that the price of a security reflects all available information but instead Zweig’s own Emetic* Market Hypothesis, which says if the mere thought of owning an asset turns your stomach, that probably is a sign to buy it. *Emetic – a medicine or other substance that causes vomiting.

He goes on to say that after years of strong returns, U.S. stocks are back near their all-time highs and the rosy recent past makes investing in U.S. stocks feel comfortable, though their high prices suggest future returns may be tepid.

Europe and emerging markets on the other hand, have felt pretty nauseating. According to index provider MSCI, U.S. stocks have lost 1.4% over the past year, including dividends. But Europe is down 12% and emerging markets have fallen a sickening 21.8%.

These markets have been awash in bad news. Zweig cites price-to-book value, a measure of corporate net worth. Since 1970, according to data from MSCI, the average price-to-book value of European stocks has been about 25% below that of U.S. stocks. As of April 30, it is 40% lower. The dividend yield on European stocks, historically about one-third higher than in the U.S., is 69% higher.

In emerging markets, where MSCI’s data began in 1995, the price to book is only half that of U.S. stocks, about a 10th below its historical average. “A lot still could go wrong in emerging markets,” says Rob Arnott, chairman of Research Affiliates, a firm in Newport Beach, CA whose strategies are used to manage about $160 billion. “But the reciprocal question is: What could go right?” Mr. Arnott says. “All it takes to create a bull market is for things to go a little better than expected.”

Zweig says that if you own an international stock fund; check its website to see how much of its portfolio is in Europe and emerging markets. Not counting the U.S., European stocks make up about half the value of global markets and emerging markets roughly another 15%. Anything less and you are underexposed to undervalued assets.

He concludes his article by saying that even professional managers whose job it is to invest in Europe and emerging markets put those markets somewhere between 6 and 8 on a nausea scale of 1 to 10. That isn’t as sickening as investing felt during the global financial crisis – but it probably is just bad enough to lead to lucrative returns later.