Cheap Versus Expensive Countries

Value on Country Level

May 2019. Reading Time: 10 Minutes. Author: Nicolas Rabener.

SUMMARY

  • A global value portfolio on country level features structural country biases
  • Returns were positive since 1990, but lacked consistency
  • Value on country and single stock level exhibit the same trends, highlighting common performance drivers

INTRODUCTION

Holding Value stocks is emotionally challenging as cheap valuations are usually due to companies experiencing temporary or structural issues such as declining sales, a lack of strategy, poor management, excessive leverage, or a combination of these. Investors might expect to get compensated for holding painful stocks and indeed research highlights positive excess returns over the long-term. However, the strategy has not been rewarding over the last decade. All pain, no gain.

An alternative to selecting single stocks is to focus on entire countries and rank these as cheap or expensive. The rationale for abnormal returns from buying cheap stocks should apply on country level as well. From the perspective of a current Value portfolio, this might result in replacing the shares of Deutsche Bank with indices for Greece or Portugal, which are two countries that have been trading cheaply in recent years given structural problems in their economies.

Perhaps buying cheap and selling expensive countries has been performing better than the same strategy on single stock level and presents an attractive alternative for harvesting returns from the Value factor. In this short research note, we will investigate Value on country level.

METHODOLOGY

We focus on the Value factor in a universe of 25 developed stock markets, which are sorted by price-to-book and price-to-earnings multiples as well as an equal-weight combination of both. Fundamental data is aggregated from company to country level from all stocks with a market capitalization of above $1 billion. Beta-neutral, long-short portfolios are created by buying the 30% cheapest and selling the 30% most expensive countries. Portfolios are rebalanced monthly and each transaction incurs costs of 10 basis points.

BREAKDOWN OF THE GLOBAL VALUE PORTFOLIO

Investors might be concerned that buying cheap countries implies exposure to more risk, which it partially does. A breakdown of the global Value portfolio