The old saying that “things can always get worse” seems to be an apt description for markets so far this year. A poor start to the year has snowballed into an environment in which investors are being paid to “sell the rallies.”
Year-to-date global equity markets are down roughly 10 percent in dollar terms, as measured by Bloomberg performance data for the MSCI ACWI Index (ACWI). While a few markets, notably Canada and Mexico, are flat to nominally higher, several market segments, including U.S. biotech, China and Italy are down more than 20 percent since the start of the year, according to Bloomberg data for the Nasdaq Biotechnology index and the respective MSCI country indices.
Against this backdrop, bargain-hunting investors are asking whether there may be opportunities.
My take: Given that the sell-off is occurring in the aftermath of a multi-year bull market, stocks overall still aren’t cheap. That said, it’s not too early to begin compiling a shopping list of potential bargains that may be worth considering.
While the selling has returned some value to equities, the best that can be said is that most markets now look reasonable. According to a BlackRock analysis using Bloomberg data, a global benchmark (ACWI) is trading at around 16.5x trailing earnings, down around 7.5 percent from last summer’s peak but roughly in-line with the 10-year valuation average. Global stocks look cheaper on a price-to-book (P/B) basis, but with the exception of emerging markets equities, they are only trading at a small discount to their 10-year average.
If valuation is unlikely to put a floor under markets, there are two other scenarios that could help establish a bottom: signs of economic stabilization or a more aggressive, coordinated response from central banks. As I don’t view either as imminent, markets are likely to remain volatile in the near term.
There’s Value to be Found if You Know Where to Look
However, for investors looking to bargain hunt, there are certain segments of the market that are trading at a significant discount. While it may still be too early to pull the purchase trigger, these two segments in particular are worth a closer look.
1. Emerging Markets
After underperforming for the better part of the past five years, emerging market stocks, as measured by the MSCI Emerging Markets Index, are one of the few, genuinely cheap asset classes. At roughly 1.25x trailing book value, emerging market equities are trading at a level last seen at their trough in early 2009. On a relative basis, using the MSCI World Index as a proxy for developed markets, EM stocks trade at nearly a 35 percent discount to developed markets, the largest such discount since the market bottom in 2003, according to an analysis of data accessible via Bloomberg.
2. Energy stocks
The other universally unloved asset class is energy. While assessing “fair value” is always an elusive exercise when discussing commodities, the recent plunge in oil prices seems to have created value in energy-related companies. With energy firms’ earnings still plunging, their price-to-earnings (P/E) ratios don’t look very appealing. However, based on P/B measurements, the sector, as represented by the S&P 500 GIC Energy Sector, is trading at the lowest level of the past twenty years and at about a 45 percent discount to the broader U.S. equity market. Even assuming future write-downs, the current discount looks large.
Emerging markets and energy have another argument in their favor: Over the past several months, rising volatility has begun to chip away at the momentum trade. Long positions in biotech and tech darlings have already been hit. Downside momentum plays continue to work, but being underweight, or short, energy or emerging market stocks have become very crowded trades. Similar to what has happened to long-side momentum plays, such downside momentum trades are likely to violently reverse at some point. When that occurs, these two segments appear well positioned to benefit.