It’s one of the most fundamental and enduring relationships in finance. As fear and risk rise, the valuations become more enticing. When all hope is gone, and the last bull throws in the towel, the prospective returns are probably at their highest.
Simple enough, right? The lesson: buy at maximum pessimism or when blood runs in the street, to quote the infamous Rothschild axiom. Sound advice, and perhaps the only true piece of wisdom for dealing with the capital markets. Alas, it’s devilishly difficult to pull off. One reason: no one knows where the bottom is except with the benefit of hindsight.
Another reason: investors tend to be human, and humans tend to trip over that emotion thing every now and again.
So it goes. Pessimism rises, and the more it rises the more likely higher expected returns will be ignored. Of course, there’s always a reason to ignore the seemingly higher odds of richer prospective performance, and much of that has to do with negative signs on recent trailing returns. It’s tempting to think that because recent history has thrown us a pair of concrete shoes, it’ll continue to do so for the foreseeable future. The effect works in reverse, of course: positive returns are expected to continue after a long string of gains in the recent past.
An antidote to giving recent performance too much weight in your strategic decision making comes by way of relative valuation. That includes trailing dividend yields among the major regions of the world. As per our chart below, dividend yields are up in the developed world’s capital markets, as per data from S&P/Citigroup Global Equity Indices through the end of last month. Europe in particular offers comparatively rich yields.
The U.S., by contrast, looks a lot less compelling on a dividend-yield basis. That doesn’t mean that domestic stocks won’t outperform European equities. But if we limit ourselves to what we know, the numbers speak for themselves.