Brian John Gabriel
Where in the World is Alpha?
Updated: Oct 13, 2021
England's FTSE index will likely outperform the S&P 500 index in the near future. For even more Alpha, look further East.
The FTSE index (England), Shanghai index (China), and Hang Seng index (Hong Kong) are likely to outperform the S&P 500 index (United States) over the upcoming year. When the S&P 500 index outperforms the Shanghai index for twelve months, the Shanghai index subsequently outperforms for twelve months on average. Below is a graph showing the rolling difference in 12 month returns for the Shanghai index and the S&P 500:
Data: Koyfin.com (Shanghai index), Robert Shiller (S&P 500 index)
Note how the Shanghai index began in 1991 with tremendous out-performance against the S&P 500 reaching 975% for the twelve months ending June of 1992. When the graph dips below zero, this indicates that the S&P 500 has outperformed over the past twelve months. As of October 2021 the graph dipped to -17% meaning that the S&P 500 outperformed the Shanghai index by 17% over the past twelve months. Note how the graph tends to ‘revert to the mean’ or cross back above zero after being negative. This indicates that when the S&P 500 index outperforms for twelve months, the Shanghai index tends to outperform for the following twelve months.
Specifically when the S&P 500 index outperforms the Shanghai index for twelve months, the Shanghai index returns on average 13.8% over the next twelve months; whereas the average annual return for the S&P 500 is 8.7%. Similar bullish patterns also exist for the Hang Seng index. We recently allocated 11% of the Gabriel Private Alpha Fund to China, 7% to Hong Kong, and 3% to Europe and believe that these markets will outperform the S&P 500 in the near future.
None of our investments garner more incredulity than the investments in China and Hong Kong. In our defense we diversify and never invest more in investment theses (i.e. that the Shanghai and Hang Seng indices will outperform the S&P 500) than we can afford to lose. There is political risk inherent with investing in China. Recently a US submarine ran into an unknown object in the South China Sea, and China has increased military flights over Taiwan. A conflagration in the South China Sea or Taiwan could cause capital markets to drop. More remotely, China and the United States could sever capital flows jeopardizing American investments in China (and vice-versa).
However severing capital flows would be very harmful to both countries and is very unlikely to occur. China is also unlikely to risk international outrage by sparking a conflagration before the Winter Olympics in February 2022. If you are sensitive to geopolitics, this permits a window for investing in China over the next several months. Our largest investments in Asia are the Xtrackers Harvest CSI 300 China A-Shares ETF ASHR (7% of our Fund) and iShares MSCI China ETF MCHI (also 7% of our Fund).
While we believe that China's Shanghai index, Hong Kong’s Hang Seng index, and England’s FTSE index will outperform the S&P 500 index in the near future, we are still Bullish for the S&P 500 and the United States. An intrepid investor will find undervalued companies in the United States, particularly in small cap (Russell 2000) stocks. Look for companies with low Price to Sales ratios (under 2 is very good) and growing revenues.
Our macroeconomic model indicates that the likelihood of a bear market at the end of the year into the beginning of 2022 is low. Partisanship over the debt ceiling deadline could cause a correction that will hit small cap stocks hard. The next debt ceiling deadline is December 16th. Very aggressive investors could hedge for volatility (i.e. by purchasing put options for a week or two before deadlines). However we are long-term investors and consider the odds of a bear market remote enough that we will not hedge for these deadlines. Those seeking Alpha will likely find opportunities in the Shanghai index, Hang Seng index, and in undervalued small cap U.S. equities.
This report reflects the current opinion of the author. The report is based upon sources believed to be accurate and reliable. Opinions and statements about the future expressed in the report are subject to change without notice. The report is not a solicitation or an offer to buy or sell any security.