VEU - VEU: Weaker Growth Prospects And Still Not Attractively Valued

2023-03-08 12:39:24 ET

Summary

• Vanguard FTSE All-World ex-US ETF invests in large-cap stocks globally.
• The fund has a weaker growth prospect than the S&P 500 Index.
• According to Warren Buffett Indicator, VEU’s fund is still not attractive enough.

Introduction

Sometimes we may want to invest our money in foreign countries and wonder which ETF provides the best option. In this article, we will analyze Vanguard FTSE All-World ex-US ETF ( VEU ) to help investors to see whether this is a good investment vehicle for investors seeking exposure outside of the United States.

ETF Overview

VEU has a portfolio of large-cap stocks outside of the U.S. The fund provides good diversification around the globe as there are over 3000 stocks in its portfolio. VEU's portfolio may continue to trade range-bound due to the unfavorable macroeconomic environment, namely the Federal Reserve's continual rate increases. Its long-term growth prospect appears to be inferior compared to the S&P 500 index. Its valuation also appears not attractive at this level based on the Warren Buffett Indicator. Therefore, we do not think investors should buy the fund right now.

Fund Analysis

2022 was a brutal year for VEU

Let us first take a look at what happened to VEU last year. Like other equity funds, VEU has suffered tremendous losses in 2022. From the beginning of 2022 to the trough reached in October, the fund delivered a loss of 29.6%. Even including dividends, the loss would still be over 28%. In contrast, the S&P 500 index saw a smaller but still significant total loss of 24.4%.

Is the recent rebound sustainable?

Following the trough reached in October 2022, VEU has rebounded by about 19% and on the other hand, the S&P 500 index has rebounded by about 11.3%. The rebound in the past few months appears to be the result of the Federal Reserve's indication of a slower rate hike trajectory. Some may wonder whether this rally will continue and form a new bull market. However, we think this may still be a bear market rally due to persistent inflation. Chairman Powell's speech this past Tuesday clearly indicated that the Federal Reserve may aggressively raise rates again if inflation growth climbs upward. At the moment, we still have a hot job market and low unemployment rate. Since wage growth can be very sticky, inflation will be very difficult to tame. Therefore, we think the Federal Reserve will likely continue its rate hike trajectory, albeit at a higher pace than the market currently anticipates.

In this environment, it will be hard to see a sustainable rally for ETFs like VEU. As can be seen from the chart below, VEU's fund price tends to be inversely correlated to the strength of the U.S. dollar. If the Federal Reserve continues to raise rates upward, it will result in a strengthening U.S. dollar. This will cause VEU's fund price to decline.

Should you be a buyer of VEU?

To answer the question of whether to invest in VEU, we can look at two aspects. First, since we have a long-term investment horizon, the fund needs to have a strong long-term growth potential. As the table below shows, VEU's portfolio is quite diversified into different sectors. However, there isn't a lot of exposure to growth sectors such as the technology sector. In fact, technology only represents about 11.6% of the total portfolio. In contrast, the technology sector represents about 25% of the S&P 500 Index. Perhaps this is the primary reason why VEU only delivered a total return of about 62% since its inception in March 2007. In contrast, the S&P 500 index delivered a total return of over 281% in the same period.

Second, we will take a look at whether VEU's valuation is fair or not. It is difficult for us to evaluate every stock in its portfolio as the fund has over 3000 stocks. However, we can analyze it broadly using an indicator that investment guru Warren Buffett often uses, the Buffett Indicator. In a Forbes interview in December 2001, Warren Buffett suggested using the ratio of market capitalization to GDP to evaluate whether the broader stock market is overvalued or not. If the market capitalization to GDP rate is in the range of 75% to 90%, the valuations of equities are usually reasonable. However, if this ratio is above 120%, the stock market is likely quite overvalued. We can use the Warren Buffett indicator to look at whether different stock markets around the world are overvalued or not.

Let us first look at VEU's exposure to different markets. As can be seen from the table below, the top 10 countries represent about 73% of VEU's total portfolio. Based on the market capitalization to GDP ratio, China and Germany's stock market appears to be cheap at 61.32% and 55.83% respectively. On the other hand, Japan, France, Canada, and Switzerland appear to be quite expensive as their ratios are above 120%. Switzerland's market capitalization to GDP ratio is even over 200%. One may argue that central banks' balance sheets have inflated so much and that this indicator needs to be revised by including the assets of these banks. Since we are in a monetary tightening environment, it is better to be more stringent when it comes to evaluating the valuation. Therefore, we still do not think VEU is currently very attractive, especially because we are in a monetary tightening environment.

Source: Created by author, Vanguard , GuruFocus

Investor Takeaway

Despite last year's market downturn, VEU is still facing macroeconomic headwinds as the Federal Reserve may still raise rates aggressively to combat inflation. In addition, VEU's valuation is not particularly attractive based on the Buffett indicator. Therefore, we are unable to recommend a buy right now. Investors may want to wait on the sidelines.

Additional Disclosure : This is not financial advice and that all financial investments carry risks. Investors are expected to seek financial advice from professionals before making any investment.

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