Research
(deutsche Version)

We examine long-term relationships of capital markets and take advantage of the insights acquired in fund management. The valuation of international equities as well as stock market and sector indices is one of our key research subjects.

Internal and external research studies have shown that long-term stock market returns can be predicted from its valuation. Therefore, current valuation ratios of selected countries and sectors can be found under Stock Market Valuation and Sector Valuation, respectively. Besides fundamental valuation ratios such as the cyclically adjusted Shiller CAPE or PB, also technical indicators like the relative strength are considered.

The Stock Market Expectations section depicts the long-term return potential for various stock markets.


Chart of the month, July 2017

What long-term returns can investors expect worldwide?

StarCapital Research

The US stock market is valuated with a CAPE of 28.0 and a PB of 3.1 by 06/30/2017. During the last 130 years, comparable valuations only led to below-average returns of 3.5% for the following 10-15 years. With a CAPE of 19.4 and PB of 1.8, German stocks promise considerably higher returns. Currently, the highest returns can be expected for the Emerging Markets.

Details on the calculation methodology can be found in our research paper Predicting Stock Market Returns Using the Shiller CAPE.


StarCapital AG


Update: Long-term market potential based on findings: US 4.3%, Europe 8.0%, and Emerging Markets 8.4%.

Our results indicates that only price-to-book ratio and CAPE enable reliable forecasts on subsequent stock market returns and market risks.

Value-investors might be able to improve their returns by taking account of momentum indicators.

Our findings suggest that the excess returns of value strategies can be enhanced by adding momentum-considerations into the investment decision.

This study analyses the relationship between cyclically adjusted price-to-earnings ratio (PE10, Shiller-PE, CAPE) and long-term stock market returns.










RESEARCH IN CHARTS



WHAT DOESN'T WORK ON WALL STREET



Selected internal research insights and their relationships are presented graphically. The following charts begin with some rarely discussed fallacies in the financial markets …

Every year in December, well-respected banks publish their next year’s stock market forecasts. Investigating the relation of forecasts and reality, it turns out that these sophisticated forecasts don’t predict future performances better than most naive forecasts. For instance, banks forecasts weren’t more precise than assuming a constant yearly stock market return of 9 %. This result remains true for every arbitrarily chosen return between 9 % and 16 %!

From our point of view, short-term performance is not predictable – hence, we renounce developing short-term predictions.

Over the past 100 years, global equity investors generated real capital growth of about 7 % annually. No other form of investment – whether bonds, cash, gold or real estate – offers comparable return potential. Nevertheless and in spite of the persistent low-interest environment, German life insurance companies currently only invest 4 % in equities. Furthermore, they turn out to be lousy market timer: having held the highest equity exposure in 2000 – just before the New Economy bubble burst – they sold stocks on unfavorable low price levels so that the portfolios still suffer from losses of two stock market corrections whereas the DAX 30 Index rapidly recovered from these losses and reached new highs.

Conclusion: Not financial crises but pro-cyclical regulation and poor market timing result in permanent wealth losses.

The basic idea behind Discounted Cash Flow models is that a company’s value equals its discounted future earnings and cash flows. Unfortunately, even tiny misjudgments of the long-term earnings growth have a big impact on the resulting company’s value. Taken into account that the average error of analysts next year’s EPS forecasts since 1973 is 30 %, nearly any company value – and hence any stock value – could be justified based on DCF models.

Thus, we avoid predicting short-term earnings.








RESEARCH IN CHARTS



WHAT DOES WORK ON WALL STREET


COUNTRY AND SECTOR ALLOCATION



Selected internal research insights and their relationships are presented graphically. The order of appearance is content-related and is not due to the release date.

Long-term stock market returns can be predicted from its valuation. The chart illustates this relationship based on various indicators (Shiller-CAPE, price-to-earnings, price-to-book and price-to-cash-flow ratios, as well as dividend yields). Analyzing the period from 1979 to 2015, for all indicators, we found that low (=cheap) valuations were followed by higher long-term returns than high (=expensive) valuations. Therefore, investors should mainly invest in undervalued stock markets and avoid expensive markets.

Details can be found in our research study Predicting Stock Market Returns Using the Shiller CAPE.

By 06/30/2017, the US stock market's CAPE and PB are 28.0 and 3.1, respectively. During the last 130 years, comparable valuations only led to below-average returns of 3.5 % for the following 10-15 years. With a CAPE of 19.4 and PB of 1.8, German stocks promise considerably higher returns. Currently, the highest returns can be expected for the Emerging Markets.

Details on the calculation methodology can be found in our research study Predicting Stock Market Returns Using the Shiller CAPE.

The current US CAPE ratio of 28.0 was followed by long-term returns between 1 % and 6 % on average in the past. Though, the range is huge so that long-term returns of -4 % and 12 % were seen. Attractive valuations in Russia, Brazil and Singapore promise higher performances; historically, such valuations have never been followed by negative long-term returns.

Details on the calculation methodology can be found in our research study Predicting Stock Market Returns Using the Shiller CAPE.

A long-term return estimation does not disclose any information about the range of returns investors may face during the next years. Like all predictions, stock market predictions based on fundamental value indicators are subject to a high degree of uncertainty. Taking the S&P 500 as an example, the chart shows the range of returns which investors had to face in the last 130 years with a comparable valuation during the subsequent 15 years. Based on the historical experience, with 80%, the S&P 500 will trade between 2,500 and 9,200 points in 2031 (with 50% between 3,200 und 6,100 points). Furthermore, a range of 1,500 to 4,100 points in the next three years is likely.

Details on the calculation methodology can be found in our research study Predicting Stock Market Returns Using the Shiller CAPE.

Based on the December 2015 valuation ratios, the 10 most attractive countries based on CAPE led to a mean return of 15%. The highes growth rates were seen in Russia (+37%), Brazil (+37%) and Hungary (+36%). With an average return of 3%, the return of the 10 most expensive countries were considerably lower.

Valuation levels do not only forecast future long-term returns but also indicate impending downside risks. From 1979 to 2015, attractive valuations were followed by lower price declines than high valuations, as displayed in the chart. For every indicator under consideration, the chart shows the maximum losses investors could have suffered if they had sold at the worst point in time following a certain valuation level. Under these circumstances, the downside risk of stock markets increase with rising valuation levels. Thus, also seen from a risk perspective, investors should avoid expensive stock markets.

Details can be found in our research study Predicting Stock Market Returns Using the Shiller CAPE.

However, not every attractive valuation leads to a buy opportunity. Especially, the cyclically adjusted Shiller-CAPE shows considerable shortcomings in markets with structural changes, such as changes in index composition. For example, it is not very meaningful to calculate the CAPE for the MSCI Greece, where the number of stocks varied from 2 to 22 during the last 10 years. Thus, the CAPE should mainly be used in larger indices with stable compositions.

Apart from structural changes, other factors can impair the comparison among countries. Considering Denmark, the slide illustrates the effect of differing sector weights and suggests possible adjustments for valuation ratios. The sectors Healthcare, Pharma, and Biotech are represented in the MSCI Denmark with a weight of 42%, whereas the MSCI World invests only 9% in these sectors. This leads to drastic consequences in the valuation: with a PB of 4.6 since 1995, Healthcare-stocks were valued about 90% higher than other sectors. Can an index with a weight of more than 40% in such expensive sectors ever get to a neutral valuation level?

Also the overvaluation of the US stock market has to be relativized a little if differences in sector compositions are taken into account. Measured by PB, the US market trades at a valuation premium of 47% compared to the global stock market. When considering that the US market is strongly invested in the expensive Technology sector, a sector adjustment decreases the overvaluation. However, even with adjusting, a significant overvaluation remains.

The US market is not only overvalued compared to other stock markets and its own history, but also the magnitude of this overvaluation has rarely been higher than today. From 1979 on, on average, investors had to pay 35% higher prices for US stocks compared to european stocks. Currently, this premium is approximately 60%.

Currently, the prospects for US investments look bad. After years of price increases, the US market is highly overrated, the low volatility level leads to carelessness and the sentiment is euphoric as never before. However, historically, the biggest price gains occurred after crises, i.e. after phases of attractive valuations, high uncertainty and pessimistic sentiment. Contrarian investors can find more promising alternatives to the US market on our Stock Market Valuation page.








RESEARCH IN CHARTS



WHAT DOES WORK ON WALL STREET


STOCK SELECTION



After identifying attractive countries and sectors, the question arises how to invest in a meaningful way. As numerous studies have proven before, some factor strategies outperform their benchmarks in the long-run, which the following charts will demonstrate.

Academic Research provides evidence that the outperformance of value stocks (HML) towards growth stocks in the long-run is subject to substantial cycles. Whereas only seven periods of significant value underperformance have emerged since 1931, the current period is lasting for an unprecedented time of 8 years by now. However, these periods were followed by 12 years of value outperformance on average.

A fundamental undervaluation does not indicate when stock prices will rise. In fact, value-investors tend to invest too early, and often buy stocks that continue to depreciate. An undervaluation of a company is worthless until other investors recognize the undervaluation and begin buying the stock, causing its price to appreciate. Thus, momentum indicators can improve investment timing. While pure value or momentum stocks have outperformed their benchmarks by about 4% per year, value stocks with a high momentum have outperformed their benchmarks by more than double that amount.

Details on the methodology can be found in our research study Value meets Momentum.




Research Papers



January 2016

Predicting Stock Market Returns Using the Shiller CAPE

Existing research indicates that it is possible to forecast potential long-term returns in the S&P 500 for periods of more than 10 years using the cyclically adjusted price-to-earnings ratio (CAPE). This paper concludes that this relationship has also existed internationally in 17 MSCI Country indexes since 1979. In addition, the paper also examines the forecasting ability of price-to-earnings, price-to-cash-flow and price-to-book ratio, as well as that of dividend yield and of CAPE adjusted for changes in payout ratios. The results indicate that only price-to-book ratio and CAPE enable reliable forecasts on subsequent returns and market risks. In countries with structural breaks, price-to-book ratio even exhibits some advantages compared to CAPE.


Complete study: Predicting Stock Market Returns Using the Shiller CAPE (SSRN-version)
German version: Aktienmarktprognose: Das Shiller-Cape auf dem Prüfstand
Further information: Press release (german)



September 2014

Value meets Momentum

Numerous studies document that value-investors can earn a yearly 3% excess return over the benchmark. Our findings presented in this study furthermore suggest that this excess return can be enhanced by adding momentum-considerations into the investment decision. Investors choosing value stocks with a high price momentum could earn 1-5% higher yearly returns (depending on market and time frame) than by investing purely into value-stocks. The reason for this observation seems to be that investors considering high positive price-momentum in addition to a stock’s valuation improve their timing. In addition, the negative correlation between the value- and momentum-styles increases diversification and reduces portfolio volatility.


Complete study: Value meets Momentum
German version: Value trifft Momentum
German journal article: Phänomene des Marktes: Value trifft Momentum? (SmartInvestor, December 2014)
Related journal article: Momentum und Value kombiniert (Finanz und Wirtschaft, October 2015)



March 2014

CAPE: Predicting Stock Market Returns

Equity investments are subject to high volatility in the short to medium term and a crucial factor for the strategic return potential is the timing of new investments. The objective of this examination has been to answer the extent to which the timing of new exposures can be successfully chosen using the cyclical adjusted Shiller CAPE, and whether the indicator allows statements to be made on long-term equity market returns. The examination reaches the conclusion that it is possible to forecast relatively reliably the long-term equity market returns of 15 equity markets using a cyclical adjusted CAPE. The concept has demonstrated impressive results in the US market over the past 130 years and in 14 other equity markets in the period 1979-2013. It is fair to assume that this connection can also be found in other markets even if we are unable to empirically verify this theory for lack of available data.


Complete study: CAPE: Predicting Stock Market Returns (SSRN)
German version: Lassen sich Börsenkurse vorausberechnen?
German journal article: Wie es mit Aktien weitergeht? (FuW, 01/03/2014)
German journal article: Monetäres Harakiri belastet Renditeaussichten (NZZ, 12/01/2015)



November 2013

Norbert Keimling: how to find attractive investment opportunities

Can losses be predicted in advance? In the past, stock market forecasts made by banks and analysts have given reason for doubt. However, there are significant relationships between value indicators such as price-to-book ratio and long-term stock market returns. Norbert Keimling explains in this webinar how StarCapital successfully identifies investment opportunities.


Link to the video (german): Video: den lukrativsten Aktienmärkten auf der Spur?



June 2012

High growth rates involve danger...

Should investors select stocks based on the expected growth rate or rather rely on traditional fundamental indicators such as price-to-book ratio. This paper analyses this question and demonstrates the risk of predicted growth rates. We come to the result that growth stocks achieve below average returns, whereas attractive value stocks outperform the market by 3% p.a.


Link to the article (german): Hohes Wachstum birgt Gefahren...



October 2008

It's not the end of the world - analysis of current situation

Review of our 2008 market evaluation: "On the 10. October 2008, the Dow Jones experienced four major price changes of more than 600 points in opposite directions. In times of such a high volatility, it is questionable to which extend stock prices are driven by fundamentals. When fundamentals are meaningless and fear and greed take over control, new attractive investment opportunities emerge."

"Meanwhile, the financial crisis is on everyone's lips as it was in 2000, but this time people are driven by panic instead of euphoria. Right at the moment, it is impossible to say if we have already hit the bottom or not. However, long-term investments in value stocks during times of sell-offs have histroically turned out to be a good deal."


Link to the article (german): Die Welt geht nicht unter - Eine fundamentale Standortbestimmung



November 2004

Chances for success of simple value strategies

The objective of this empirical work was to assess the chances for success of simple value strategies from a private and institutional investors point of view. For this purpose, we evaluated price-to-earnings, price-to-cash-flow, price-to-book and price-to-sales ratio as well as dividend yield of seven countires and the FTSE World Index in the period 1989-2003. The study comes to the conclusion that value stocks outperform growth stocks in the long-run and simple value strategies achieve higher returns that the respective index. As the empirical analysis shows for the FTSE World Index, value investor would have outperformed the market on a 13 year basis, almost independent of the investment criteria being looked at or the number of stocks in the portfolio.


Complete study (german): Die Erfolgsaussichten einfacher Value-Strategien



If you have any further questions please do not hesitate to contact us by phone (+49 6171 - 694 19 0) or email. Contact person: Norbert Keimling