Bad Countries, Good Investments

Last week, White House press secretary Jay Carney offered a bit of investment advice.

“I wouldn’t … invest in Russian equities right now … unless you’re going short,” Carney said in response to a reporter’s challenge that Russian stocks were actually rising, signaling the inefficacy of U.S. and European sanctions.

But according to Mebane Faber of Cambria Investment Management, which subadvises ETF portfolios and issues its own, Carney’s advice was “irresponsible” for several reasons.

“First of all, you shouldn’t recommend to the general public shorting anything,” he says in an interview with ThinkAdvisor. “Most retail investors don’t understand the mechanics of shorting but also how much you can lose — the entire account plus some. Looking at Russia — its market goes up and down 5% in a day — its volatility is double that of the U.S. stock market.”

But apart from those technical and risk-based reasons, the overriding reason to short the White House’s investment advice is because Russia is likely to outperform world stock markets in the coming years,” Faber says.

“I don’t recommend shorting a market that is down 60% from its peak. If Russia settles down, Russia could very easily double or triple [in the next two or three years].

“That’s one of the most moronic statements I have ever heard out of the White House, that’s for sure,” he adds.

Moronic — “idiotic” was added later for emphasis — but also telling.

“These are statements you hear when countries are as cheap as Russia. The headlines are all negative.”

And indeed the “buy when there’s blood on the streets” investment axiom fits well, in a qualitative sense, with the quantitative approach Faber is taking in his new Cambria Global Value ETF (GVAL), which launched earlier this month.

Faber, widely followed for his investment research, blogging and controversial stance against buy and hold, has timed the release of a new book to lay out the theory behind his new ETF.

Called “Global Value: How to Spot Bubbles, Avoid Market Crashes, and Earn Big Returns in the Stock Market,” the book is premised on the Graham- and Dodd-style value investing later enhanced by Robert Shiller.

The idea is that smoothed-out earnings — Shiller CAPE, or cyclically adjusted price-to-earnings ratio, is a good example — provides a useful signal of future market performance; a high Shiller CAPE in the late ’90s, for example, foretold the bear market of the 2000s, according to this thinking.

What’s more, bubbles can be bigger abroad than in the U.S., Faber says.

“Our starting point is that the investor who is U.S.-focused should start to invest at a minimum half in foreign markets. Most invest 70% to 80% in the home market.”

Yet out of the 44 countries Cambria tracks, the U.S. happens to be one of the most expensive, weighing in at nearly half of world market cap, Faber says. That should worry investors, particularly those who remember when Japan’s market inflated to nearly half of world market cap, reaching a P/E in the high 90s.

Faber assures that the U.S. is not in a similar bubble — its Shiller CAPE is 25. “It’s a headwind, not a tailwind,” he says.

“But markets usually bottom out with secular bears with P/Es in the high single digits or 10, and top out in 30s or high 20s,” he says.