Knowledge is Power: Gold, Shining India, ETFs Due Diligence Edition

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Old Car in UK Farm

Antique car in a UK Farm

Why You Should Own German Stocks

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Germany is the largest economy in Europe and many German firms hold leadership positions at the global level in their respective fields. So when I came across an article that was way off on German stocks, I had to clarify a few issues. Fund manager and author Sven Carlin wrote a piece titled  The Case Against International Diversification: Trying To Find Good Stocks In Germany in Seeking Alpha recently. The author is incorrect on many points and few readers noted those in the comments section following the article.

Here is a summary of his article:

Due to many companies with negative earnings or high PE ratios and low growth, investing in German ETFs or index funds is not advised (especially small and mid cap).

The overvaluation of the German market is proved with companies like Zalando (PE=649) and Zooplus (PE=165) and the DAX average PE of 22.2.

Currency tailwinds aid German companies and I believe that a stronger euro would have a severe influence on their businesses.

A detailed comparison and inspection of German stocks shows that there are much better investments on the NYSE and Nasdaq.

After researching some German 447 stocks on various metrics the author came to the following conclusion:

Unfortunately not much has been found from my German research but sometimes it is good to know where not to go and not to invest. The currency tailwinds and the consequent future risks related to potential currency headwind plus the weaker fundamentals put me off from investing in Germany.

For long-term investors holding German equities is a no-brainer. Though German stocks may be volatile in short-term, they have returned positive returns in the long-term. The following fascinating chart shows the returns over various time periods:

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DAX Retunrs By Year Long Term Chart

Source: Deutsches Aktieninstitut

From a Motley Fool article that explains the above chart:

Each individual box in the triangle shows the annual return for an investor who bought the DAX at the end of one year (Y-axis) and held through the end of another year (X-axis). Green boxes show gains, boxes closer to white show flat returns, and red boxes show losses.

First, take a moment to admire all the green in that chart. In the vast majority of years and time periods, the DAX has had a positive annual return.

Now look what happens as you move down and toward the right of the triangle. The red squares disappear completely. In plain language: The longer the holding period, the higher the chance of a positive annual return. In fact, you won’t find a single 15-year holding period in the entire 50-year span of the chart that doesn’t result in a positive annual return.

Even using 10 years as a holding period, there are only two instances (out of 41 possibilities) where your returns would have ended up negative. That means that if you bought the DAX any time over the last 50 years, and held for at least 10 years, you had a 95% chance of a positive annual return.

Source: Why you need to own stocks, Motley Fool Germany, 2014

All the green squares in the chart makes it clear that German equities have returned positive returns than negative returns in many time periods. The red concentration around 2008-09 and during the dot-com crash of 2000 are understandable. So though Sven Carlin concluded that he could not find German companies worth investing in, it misses the point big time. History has shown time and again that long-term investors are richly rewarded.

Some of the excellent companies that investors can consider are Adidas AG(ADDYY), Continental AG (CTTAY), Henkel (HENKY), Fresenius Medical Care AG(FMS) and Siemens Aktiengesellschaft (SIEGY)

Disclosure: No Positions

The China Bull Is Back

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Just a few months ago the Chinese equity market plunged dramatically almost overnight. Global markets followed suit as fears of a collapse in China’s economy and equity markets would lead the world into a depression. Stocks of developed world companies which have nothing to China were also trashed during the selloff.

However a recent Journal article told us that Chinese stocks have entered a bull market. From going to a complete and utter disaster Chinese stocks are roaring again. To be sure, the bull market means that stocks have recovered by at least 20% from the troughs reached during the crash.

From the Journal article:

China entered a bull market Thursday, a surprising milestone after a volatile summer wiped out trillions of dollars in value from mainland equities and rattled global markets.

The Shanghai Composite Index has gained 20.3% since Aug. 26, the bottom of the summer selloff. A bull market is defined as a rise of 20% from a recent low.

The benchmark finished up 1.8% at 3522.82 on Thursday, bringing its year-to-date gains to 8.9%, but it is still down 32% from its 2015 high reached on June 12.

China’s smaller Shenzhen Composite Index and a gauge of China’s volatile startup shares have rallied 32% and 43%, respectively, from their recent lows on Sept. 15. On Thursday, the Shenzhen Composite closed up 0.2% at 2093.47, while the ChiNext Price Index slipped 0.8% to 2564.72. The Shenzhen market has gained 48% this year, while the ChiNext is up 74%.

Investors have gradually returned to the market after the summer selloff, which Beijing scrambled to stem. Trading volumes have reached their highest level since mid-August and Chinese investors are borrowing from their brokerages again to buy stocks.

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China Market Stats

Margin loans have climbed to their highest level in roughly two months after dropping sharply in the throes of the rout, but are still down roughly 54% from a June 18 peak of 2.27 trillion yuan ($358 billion), according to Wind Information Co. On Wednesday, margin loans totaled 1.05 trillion yuan.

Global stocks have also been rebounding from a tumble in August, when China devalued its yuan in a surprise move that raised doubts about Beijing’s ability to transition the world’s second-largest economy to a more market-oriented system. The MSCI World Index has risen almost 11% since late September.

Chinese officials dug deep into their playbook for ways to stabilize domestic markets, including pumping money into state-backed funds that bought blue-chip stocks and cracking down on short sellers and suspending initial public offerings. They even pledged to keep buying stocks until the Shanghai Composite Index reached 4500—a goal still roughly 1,000 points away.

Source: Rebounding Chinese Shares Enter a Bull Market, WSJ, Nov 5, 2015

Before an investor jumps into this bull market here are a few points to remember:

  1. The majority of investors in China are domestic retail investors – not foreign investors. These local investors are not in for the long haul and consider the equities a quick way to get rich. So violent moves on the upside and downside should be expected.
  2. Unlike Brazil and India, foreign investors are not the main shareholders in Chinese stocks due to various state restrictions.
  3. As an emerging country, the Chinese stock market is a classic follower of boom and bust cycles. The market has crashed many times in the past only to rebound sharply. So one should expect falls of 50% of more quickly anytime.
  4. The relationship between economic performance and equity markets is very weak. Hence even when the economy is growing slowly stocks can soar for any number of reasons. This is what has happened in China. Though the economy has not grown sharply in just a few months, stocks have entered a bull market.
  5. Unlike other countries, China follows a unique political and economic model. As a communist country at least politically, the communist party runs the country and can impose arbitrary rules on the functioning of the markets. Since the majority are local average retail investors, the party may not allow the market to plunge by 99% for example to prevent social uprisings. During the recent state intervention all forms of silly rules were enacted including the complete suspension of trading certain stocks.
  6. The Shanghai Composite Index closed at 3,590.03 on Friday. In August it reached as low as 2,927 and in June it peaked at 5,166. Stocks shot up to the moon from starting the year at 3,350 levels only to start the plunge after the peak in June. Now they are back in bull market mode. This one year performance of the index shows the extreme volatility of the Chinese equity market.
  7. Over 50% of the Chinese exchange-listed ADRs trading on the US markets are at below $10 a share. Many of these stocks were priced at at least $10 or more when they had their IPOs a few years ago. This shows that diving into Chinese IPOs is another worst idea for overseas investors. Some of the Chinese stocks have completely disappeared from US markets due to delisting or reverse mergers.

So in summary, though Chinese stocks have entered a bull market investors have to very cautious investing in China.

Related: The Full List of Chinese ADRs

Knowledge is Power: Happy People, Diversification Challenges, Roth Conversion Edition

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Camels

Should Investors Simply Stick With U.S. Stocks?

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The S&P 500 is up by 2.11% year-to-date. Compared to this low return, many European indices have double digit returns so far this year.For example, the STOXX 600 is up by 11% and the CAC 40 has increased by nearly 16%.

However over the past few years US equities have greatly outperformed European and other global equities as shown in the chart below:

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Global Stocks Returns Comparison

Note: The chart is based on MSCI Index returns in British Pound terms

Source: US equities: the best house on a bad street, Money Observer

The US equity market has performed extremely well due to many reasons including: the strength of the dollar, strong earnings, economics stability at home, stock buybacks, etc.

The rally in US stocks may not continue in the future. Even if US stocks do not outperform, European stocks especially have plenty of favorable factors to beat US equities. Some of the reasons to consider adding foreign developed equities to a diversified portfolio are:

  • Since European and other developed stocks have lagged US stocks they are more likely to play catch up and hence have room to grow. Moreover the best time to buy stocks is when they are cheap and valuations are low.
  • Dividend yields are generally higher overseas relative to the low 2% yield for the S&P 500.
  • Certain sectors of the US market such as utilities and transportation are lagging this year.This does not bode well.
  • Ultra-low interest rates have helped US firms engage in buyback binges of their own stocks and take on huge debt loads as well. When interest rates rise this party may not continue.