The proverb that says it’s always darkest before the dawn seems to date back to 1650. It’s an optimistic way to look at life, but it’s also a good strategy to use to look for long-term investments in stock markets where the news is so bad that it seems impossible it can get any worse.
Investors seem to be the most pessimistic about markets that, in hindsight, turn out to be important bear market lows. There are a lot of ways to measure investors’ pessimism, but for the long run, the cyclically adjusted price-to-earnings ratio (CAPE) might be among the best measures.
CAPE uses 10 years’ worth of earnings data, adjusting for the ups and downs of the economy. We tend to see important bottoms form when CAPE is below 10. As a rule, lower is better for long-term investors.
For example, in 1920, CAPE fell below 6 in the U.S., and the Dow Jones Industrial Average gained more than 300% in the next nine years. In 1982, a CAPE of 7 preceded a five-year rally of 230%.
To find low CAPEs right now, we have to look at some countries that seem overwhelmed by bad news. The world’s cheapest stock markets, with a CAPE of 5.9, are in…
Russia and Turkey.
Russia might not strike investors as a terrible investment. In 2016, it was one of the best-performing markets in the world, with a gain of almost 50%. But the market remains well below its all-time highs, as this chart of the VanEck Vectors Russia ETF (NYSE Arca: RSX) shows:
On the chart, RSX appears to be breaking above resistance with a six- to 12-month target of $27.50 — almost 30% above the current price.
Turkey’s chart is also attractive after momentum turned up recently. The iShares MSCI Turkey ETF (NYSE Arca: TUR) is shown below.
Over the next three to six months, TUR could move toward resistance at $39.90, a gain of about 15% based on the current price.
Experts worry that war could break out around either of these countries. Both are run by officials acting more like dictators than products of truly free elections. But economists expect both countries to report economic expansion this year after brief periods of contraction. And their recoveries could accelerate on any sign of good news from Syria — where both Russia and Turkey have sent military forces — or other global hot spots.
For those who believe it’s darkest before the dawn, RSX and TUR are exchange-traded funds that could be great long-term investments. For value investors, Russia and Turkey are home to the world’s cheapest stock markets. However … these opportunities are only for the brave.
Michael Carr, CMT