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Buffett Indicator for International Investing

One of famed investor, Warren Buffett's, favorite indicators is the measurement of a country's GDP to the value of its stock market. It is an easy way to gauge whether the stock market is growing faster than the underlying economy (which can be a sign of overvaluation for the stock market) or if stocks in a country are undervalued relative to their economy.

Now you can't compare country to country because every country has a different stock index with different numbers, types, and sizes of public companies. But you can compare countries to their historical trends and see if a country is over or undervalued. And right now we are seeing some pretty large extremes across the globe. 

My go-to website to track this is Guru Focus, a website dedicated to researching the methodologies of different investing gurus. They have a web page that tracks this metric for 16 of the largest developed countries and 7 of the largest emerging countries on a daily basis. They calculate the statistic and compare it relative to its history and then use that to derive an estimated return for that country's stock market. The projected return is based on (a) if the country's recent GDP growth continues and (b) if the stock market returns to its median valuation relative to GDP.

As of September 4, 2020, the website was showing projected returns for each of the 23 countries as shown in the chart above. You can see that there are 5 developed countries and 5 emerging countries with projected returns of 10% or more. Those countries and the ETFs that can be used to invest in them are:

  • Singapore (EWS) at 16.7%
  • Spain (EWP) at 12.9%
  • UK (EWU) at 11.3%
  • Hong Kong (EWH) at 11.0%
  • Australia (EWA) at 10.8%
  • Turkey (TUR) at 18.6%
  • Mexico (EWW) at 13.7%
  • Indonesia (EIDO) at 13.6%
  • Russia (ERUS) at 11.1%
  • India (INDA) at 10.0%
With my own personal investing, I look for ways to earn 10% or more in a relatively safe way. Given how well this metric has performed historically in predicting returns and the fact that I know I'd be buying these countries at a discount to their historical norm, I would certainly give each one of these serious consideration for my own portfolio.

One thing I would research before investing is the inflation for each country. These returns are gross including inflation. So using Turkey as an example, the 18.6% return might look impressive, but the country's inflation rate has climbed from 8% to 16% over the last four years. So that means the real return net of inflation would only be 2.6% if inflation continues at 16%. That is certainly not enough to get me excited given Turkey's performance and risk attributes.

Also, another thing to research is whether there is a stock or an industry that dominates a particular country's index. As an example, 20% of the Spain index is currently comprised of their main utility company, Iberdrola. So it is important to know that this company's performance has a major impact on the performance of Spain's entire stock market.

The other takeaway from the chart above is that there are currently two countries with projected negative returns - Japan at -1.7% and U.S. at -2.9%. This shows how extreme both these countries' stock markets are relative to their history, and why investing in either market right now needs to be done with careful consideration. Even if GDP continues to grow, the level of valuation is so extreme that it could result in negative returns. And remember, these returns include inflation. So if the Fed really hits its 2% inflation target, the real stock market return for the U.S. would actually be -4.9%! You may be better off keeping your money in a savings account than in the U.S. stock market right now because at least that would only be a -2% return. 

So start tracking this key indicator today across countries using the Guru Focus website. If there is a country that they don't track that you'd like to research, I've found good historical data on the World Bank website. Here is the link for GDP by countrymarket cap by country, and inflation by country