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The chart below shows the cumulative performance (in AUD) of Australian, global and emerging market share over the 3 years to the 10th May 2018.


Global and emerging market shares are up over 25%, while Australian shares are up a little over 20%. You might be wondering, where two from now?

I’m a big believer in the importance of conceptual frameworks. They are an essential tool in asset allocation. A logical and well-researched framework helps me to make consistent comparisons over time. It promotes disciplined decision-making. And it keeps me focused on what I can control and improve – my investment process.

A simple framework that my friends at Heuristic Investment Systems and I use considers a range of variables, which we group into four main categories:

  • Value – How does the price of an asset compare to a) history and b) other assets?
  • Policy and Liquidity – Are financial conditions (central bank policy, liquidity) easy or tight?
  • Macroeconomic Change – Is economic activity accelerating or slowing down?
  • Momentum – Has recent performance been up or down?

There’s a brief description of these four indicators in my last post.

Last time, I demonstrated how this framework can be used analyse an asset class over time. We considered emerging market shares and how they scored across our four indicators at different times over the last two years.

This time, we’ll use the same framework to compare across asset classes at a point-in-time. We’ll compare Australian shares (S&P ASX 200 Index) to global developed (MSCI World Index) and emerging market (MSCI Emerging Market Index) shares.

Let’s start with value. The scores are a standardized composite of 3-4 different measures. The bars indicate the historical maximum and minimum for each measure. The boxes indicate the range of scores that mark a significant deviation from the long-term average. This is shown by the dotted line in the box.


Australian shares are expensive, but still within their normal valuation range. They’re expensive when measured using a long-term price/earnings ratio (CAPE Ratio). Australian shares also expensive when measured using trend[1] and sector[2] adjusted price/earnings ratios.

Global shares are the most expensive. This is due mainly to the over-valuation of US shares. The US stock market is approximately 60% of the world index. While global shares are significantly overvalued, they have been even more expensive in the past. This is a good reminder of why value – which matters enormously for future investment returns – is such a poor short-term forecasting tool. 

At first glance it looks like Australian shares are more expensive. The value indicator score is low, but it’s still within its normal range (which is wider than the other two markets). Meanwhile, global shares currently sit outside of their normal range. The historical valuation range for global shares is narrower. This makes sense as global shares are a diverse group of 23 different share markets. Some markets will be expensive, while others are cheap. This netting out of value across markets reduces the range of scores that deviate significantly from the long-term average.

Emerging market shares are the cheapest. This is mainly due to the fact that are cheap relative to other equity markets. They are currently fair value relative to their own history.

Policy and Liquidity doesn’t tell us much. The indicators show that monetary policy and liquidity conditions “isn’t too hot, nor too cold but just right”. This is quite a change from the last few years where policy and liquidity have been extremely accommodative.


Global shares continue to enjoy a favourable macroeconomic environment. The positive macro score is due largely to the on-going strength of forward earnings expectations. Once again, this is largely being driven by the US stock market.


In contrast, the macro score for Australia has deteriorated. All three indicators: global economic growth momentum, Chinese industrial new orders and forward earnings growth expectations have slowed down. It’s worth pointing out that the model is designed to focus on change, which has begun to slow. That said, the level of economic activity is still positive.

It’s is an interesting example of why it’s important to understand what’s in a model. A model is only a tool. They are great for highlighting the factors that require attention. But they also require the application of common sense when interpreting the results.

The macro score for emerging market shares is negative, but still within its “normal” range. One reason is the slowdown in forward earnings growth expectations. This could be due to rolling 12-month comparisons being tougher to beat after the strong earnings growth in recent months.

Finally, we come to momentum. There’s often a fairly high correlation between the macro and the momentum scores. Share prices tend to move with what’s happening in the economy, at least over the short-to-medium term.


Once again, global shares have the strongest score. Momentum is neutral for Australian shares and slightly negative for emerging markets. All of the scores are within their “normal” ranges. Negative momentum in emerging market shares is partly due to expectations of rising US bond yields and a stronger US Dollar (historically a negative for emerging markets).

How do we put this all together? The answer depends on your investment horizon, circumstances and objectives.

Long-term investors should arguably pay more attention to value as it’s a significant driver of future investment returns. Value currently argues in favour of emerging market shares. Not so much because they are cheap, but because the alternatives are expensive.

Macro and momentum favour global equities, but not significantly. This is largely a US earnings story. The forward guidance from US companies has been unusually strong in recent months. Marco variables tend to work best over the short-to-medium term (i.e. 6 to 24 months). Momentum on the other hand, works best over the short-term (i.e. 3 to 12 months).


Few things in investing are either black or white, which is why it’s important to use a framework to help you make better investment decisions.

Asset allocators should consider a range of indicators as part of a systematic and disciplined investment process.

The indicators and the importance assigned to them should match the investor’s time horizon.

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[1] To adjust for extraordinary earnings during the mining boom.

[2] To adjust for the high-level of sector concentration in financial and resource stocks in the Australian share market, relative to global share markets.