#$gval

It’s an old joke among value investors that none of us are ever “wrong.” We’re just “early.”

There is actually a lot of truth to that statement. It’s rare to find a good value investor who is also a good market timer. (It’s also hard to find good market timers—period—but that’s a different story for a different day.) A cheap stock can stay cheap for longer than you expect—as can entire markets—but over time, value strategies have proven to outperform. 

This brings me to one of my favorite long-term ETF holdings, the Cambria Global Value ETF (GVAL). 

Cambria’s timing could have been a little better. They launched GVAL—an ETF that invests mostly in non-U.S. value stocks—in March of last year. This was just months before emerging markets and non-U.S. developed markets (i.e. everything that GVAL owned at the time) rolled over and gave up substantially all of their gains for the year. 

GVAL was launched at $25 per share and bottomed out at $18.80 early in January of this year—generating losses of 25% in about 9 months. 

Ouch. 

GVAL has gotten off to a humble start. But if you’re a believer in value investing as a discipline, then GVAL deserves a serious look. In a market in which the U.S. has outpaced its foreign competitors for years, I consider GVAL to be an excellent, diversified rebound play on Europe and emerging markets. 

Let’s take a look under the hood.  In building GVAL’s portfolio, Cambria starts with a universe of 45 world markets and reduces this to the cheapest 25% as ranked by Cambria’s models. Cambria’s methodology is based mostly on the cyclically-adjusted price/earnings ratio (“CAPE”), a metric used by Benjamin Graham and made famous more recently by Yale Professor Robert Shiller. 

From these cheapest 25% of world markets, Cambria then builds a portfolio of about 100 stocks with market caps over $200 million. The result is a global mid-cap value portfolio of stocks in countries where investors might normally be scared to tread. GVAL’s current country allocation is a who’s who list of problem countries:

Brazil—a country engulfed in a major corruption scandal surrounding state oil major Petrobras (PBR)—is tied with Ireland as the largest country allocation at 12%. Spain, which is facing a secession movement in Catalonia in addition to its economic woes, Israel and Austria round out the top five. And moving a little further down the list, we get to the really scary countries like Russia and Greece. 

But herein lies the beauty of GVAL. Few investors would have thick enough skin to take a large position in any of these countries individually. But even investors with nerves of steel would have trouble building a viable portfolio of stocks from most of these markets due to the lack of available U.S.-traded ADRs to buy. Very few investors have access to the small and mid-cap foreign stocks that dominate GVAL’s portfolio. (Think about it; how would you go about buying a small-cap Israeli stock even if you wanted to?)  At best, you might be able to buy a cap-weighted country ETF that holds only the largest and most liquid stocks. In GVAL, you can systematically invest in pockets of the market that would normally be off limits. 

So, what’s next for GVAL? Only time will tell. The value investor's curse is that cheap stocks can stay cheap for a lot longer than you planned. But consider these comments made late last year by GVAL's manager, Cambria's Meb Faber:

1/ US stock valuations relative to foreign stock valuations will close at the highest level over the past 30 years... — Meb Faber (@MebFaber) December 30, 2014

2/ Four out of five of the biggest relative valuations resulted in big foreign outperformance the following year. Only exception? 2014 — Meb Faber (@MebFaber) December 30, 2014

If history is any guide, GVAL should beat the pants off the S&P 500 this year...and for several years to come.   

Charles Lewis Sizemore, CFA, is chief investment officer of the investment firm Sizemore Capital Management and the author of the Sizemore Insights blog.

2014 was a lousy year for global value investors. Cheap markets, as measured by the cyclically-adjusted price/earnings ratio (“CAPE”) got even cheaper, while expensive markets got even pricier. (Note: the CAPE takes a ten-year average of earnings as a way of smoothing out the economic cycle and allowing for better comparisons over time.)

I expect this to reverse in 2015. At some point--and I'm betting it could be as early as the first quarter--global market valuations should start to revert to their long term averages. That's fantastic news if you're invested in cheap foreign markets. It's not such fantastic news if your portfolio is exclusively invested in high-CAPE American stocks.

Let's take a look at just how skewed the numbers are. The S&P 500 managed to produce total returns of 13.7% in 2014. But as quant guru Meb Faber pointed out in a recent blog post, globally, the median stock market posted a loss of 1.33%. The cheapest 25% of countries saw declines of 12.88%, while the most expensive markets actually gained 1.36%.

I should throw out a couple caveats here. These were the returns of U.S.-traded single-country ETFs, which are priced in dollars, and not the national benchmarks. The strength of the U.S. dollar relative to virtually every other world currency last year was a major contributor to the underperformance of the rest of the world.

All the same, it's worth noting that we're in uncharted territory here. As Faber noted in a recent tweet, U.S. stock valuations relative to foreign stock valuations closed 2014 at the highest spread over the past 30 years. Four out of the five biggest relative valuation gaps resulted in outperformance by foreign stocks the following year. The only exception was 2014.

Let's dig into the numbers. The CAPE for the S&P 500 is now 27.2. That's a full 63.9% higher than the historical average of 16.6, more expensive than at the 2007 peak, and close to the 1929 peak. The only time in U.S. history where the S&P 500 was significantly more expensive based on CAPE was during the peak of the 1990s tech bubble.  

Sure, the "fair" CAPE is going to be a little higher today than in decades past due to record low bond yields (all else equal, lower yields mean higher "correct" valuations). But I should point out that yields are even lower in most of Europe and Japan, yet valuations are significantly cheaper. So while low bond yields might partially explain why U.S. stocks are expensive relative to their own history, it doesn't explain why the U.S. is expensive relative to the rest of the world.

No matter how you slice it, U.S. stocks aren't the bargain they were a few years ago. Research Affiliates calcuates that U.S. stocks are priced to deliver returns of about 0.7% over the next 10 years. Using a similar methodology, GuruFocus calculates an expected return of about 0.4%.

I've driven home how expensive U.S. stocks are. Now, let's take a look at other global markets. Here are the world's cheapet markets as measured by the CAPE and sister valuation metrics cyclically-adjusted price/dividend ("CAPD") cyclically-adjusted price/cash flow ("CAPCF") and cyclically-adjusted price/book ("CAPB").  All figures reported in Meb Faber's Idea Farm using original data from Ned Davis Research.

We see some familar names on the list. Greece remains the world's cheapest market by a wide margin. Of course, Greece is also in the middle of an election cycle that may well result in the country getting booted out of the Eurozone.

Interestingly, Russia is cheap following Western sanctions and the collapse in the price of oil, yet there are several far more stable countries that are cheaper, such as Austria, Portugal, Hungary and Italy.

Two countries that I've liked for years based on valuation--Brazil and Spain--round out the top ten. To put things in perspective, Spain trades at nearly a 60% discount to the U.S. market based on CAPE.

Yes, Spain has its problems. Its economy is stuck in a slow-growth rut, and unemployment remains over 20%. But Spain is also home to some of the world's finest multinationals, such as banks BBVA (BBVA) and Banco Santander (SAN), telecom giant Telefonica (TEF) and fashion retailer Inditex (IDEXY).

There are different ways to use this data. You could buy and hold country ETFs, such as the Global X FTSE Greece 20 ETF (GREK), the Market Vectors Russia ETF (RSX) or the iShares MSCI Spain ETF (EWP). Or you could go with a convenient one-stop shop like Faber's Cambria Global Value ETF (GVAL).

GVAL is nice collection of cheap stocks from around the world. As of last quarter, GVAL's largest country weightings were to Brazil, Spain and Israel.

Disclosures: Long GVAL, EWP, BBVA, SAN, TEF

Charles Lewis Sizemore, CFA, is chief investment officer of the investment firm Sizemore Capital Management and the author of the Sizemore Insights blog.