Jordan: Hello again everyone. Welcome back to episode two of The Atlas Investor podcast with Tiho Brkan. Thank you so much for joining us today. Tiho, my friend. Are you ready for episode two?Tiho Brkan: I sure am.Jordan: So Tiho, you are in Montenegro today. Tell us what city you are in and what else we’ll be discussing in episode two.Tiho Brkan: Well hello to all the listeners. Yes, I’m in a beautiful little country of Montenegro on the Adriatic coastline, adjacent to a neighboring Croatia, Bosnia, Serbia, Albania, and also, across the waterways, Italy. We’ll be discussing a lot about Montenegro real estate and then we’ll get into what I think it will be a very interesting discussion between me and you Jordan, which is foreign stocks, in particular, emerging market stocks.Jordan: Tell us
Tiho Brkan considers the following as important: Austria, Budva, CAPE valuations, complacency, Cost of living, Eastern Europe, Eurozone debt crisis, fund managers, individual taxes, international taxes, Israel, Italy, Kotor Bay, lost decade, market correlations, merrill lynch fund manager survey, Momentum, Montenegro, Norway, personal income tax, Podcast, Porto Montenegro, Portugal, price to book ratio, price to earnings ratio, Real Estate, Recession, recession risks, S&P 500, Sentiment, Singapore, Spain, stock market correction, stock market valuations, tax planning, The Balkans, tourist arrivals, United Kingdom, US Dollar, US Stock Market, US stocks, Valuations, VAT
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Jordan: Hello again everyone. Welcome back to episode two of The Atlas Investor podcast with Tiho Brkan. Thank you so much for joining us today. Tiho, my friend. Are you ready for episode two?
Tiho Brkan: I sure am.
Jordan: So Tiho, you are in Montenegro today. Tell us what city you are in and what else we’ll be discussing in episode two.
Tiho Brkan: Well hello to all the listeners. Yes, I’m in a beautiful little country of Montenegro on the Adriatic coastline, adjacent to a neighboring Croatia, Bosnia, Serbia, Albania, and also, across the waterways, Italy. We’ll be discussing a lot about Montenegro real estate and then we’ll get into what I think it will be a very interesting discussion between me and you Jordan, which is foreign stocks, in particular, emerging market stocks.
Jordan: Tell us a little bit about the country and some general information for those who aren’t familiar.
Tiho Brkan: Montenegro is a very, very small country in the southern part of the Balkans on the Adriatic Sea. The population is 680,000 people and the GDP is 4.2 billion. So GDP per capita is six … almost 7,000 USD. To be precise, it’s 6,800 USD. It’s a very small country with not a lot of industry, Jordan, so the primary focus of Montenegro seems to be tourism.
Jordan: Okay Tiho. I know we’re going to talk a little bit about tourism later, but is Montenegro an interesting country for investors?
Tiho Brkan: I would say so, but it’s not a very easy country to play for an investor. There is no stock market exposure and it’s not that easy to purchase real estate. I think, you have to come to Montenegro and you really got to see all of the real estate that’s available. You got to actually go through various cities on the coastline, and you got to understand the market. Generally speaking, one thing that’s very interesting about Montenegro is — despite the fact that they are not in the European Union — they’ve been using the Euro for a number of years. As of June this year, they joined the NATO, Jordan. And that tends to be the first step toward the Eurozone entry. So there is a potential here for real estate to become repriced higher if indeed they follow the likes of Croatia, Romania, Bulgaria and other Balkan states that are attempting to enter the Eurozone.
Jordan: Okay, Tiho, so that being said, what is the real estate market? I mean, what is it priced like right now, at this moment?
Tiho Brkan: Well one of the popular parts of Montenegro coastline is a town called Budva with a famous resort of Saint Stefan, which used to be a famous playground for celebrities and movie stars back in the 1960s. Now, it is kind of a forgotten country and part of the world, due to the Balkan War of the 1990s. The price we’re looking at is about below 3,000 USD a square meter, which is below 300 USD a square foot. So on the higher end, you also have an interesting development happening in Porto Montenegro, and this is where I currently am. This is bordering Croatian side, and there is a UNESCO protected bay, it’s called the Bay of Kotor. And it’s splendid, it’s a terrific piece of Mother Nature. I’ve never seen quite a mix between clear waters and stunning mountains.
Real estate in this area here is quite fascinating to me because you have a mix between Porto Montenegro development, which I just discussed, which is kind of like a brand new, modern side of real estate, and then you have the old stone houses of Kotor Town and Perast Town, which are built in maybe 1400s, 1500s, depending. A lot of different history gets mixed here, all the way back to the Venetian Empire days. So it’s very interesting. So there’s a budget for everybody, Jordan.
Jordan: Okay, Tiho. Let’s shift a little bit and talk about business opportunities. Do you see any business opportunities in Montenegro?
Tiho Brkan: Business opportunities, I would say, not really. In episode one of the podcast, we discuss Serbia and I was raving on about the tech-savvy, talented youth of Serbians who are well-spoken in English and extremely bright individuals, especially the ones that are attempting to source their skills on the outside, into the Eurozone and into United States, Silicon Valley and so forth. And they’re quite competitive on the global stage. On the other hand, Montenegrins, not so much. The country’s quite behind in education, and when it comes to business, there would be a handful opportunities here and there because it’s quite underdeveloped, but I would say the only one that really stands out for me at this point, and stands out clearly, is tourism.
Jordan: So just to follow up with you, Tiho, just delve a little bit deeper, and be specific. What would the opportunities be as far as tourism?
Tiho Brkan: Well, catering to tourists from all scopes, I think. Montenegro is quite underdeveloped, so when I look at the tourism, the tourist arrivals in the smaller country of Montenegro, I think are 1.6 million, relative to over 16 million for neighboring Croatia, where I’ll be going next week. So Croatia obviously has famous cities on the coastline, including Dubrovnik, which is the King’s Landing from Game of Thrones. They’re a part of the European Union, so they’re attracting quality tourists, plus tourists from Korea, from Canada, America, Australia, New Zealand, South Africa and so forth, the Anglo-Saxon-speaking countries.
On the other hand, Montenegro is, at this point in time, a budget place for, I guess, lower quality tourists. They are trying to change this, relatively speaking. They are trying to change this by developing higher-end real estate resorts, the likes of Porto Montenegro, Lustica Bay, and Portonovi. Some of these are an extremely high end, very expensive, cater towards higher net worth individuals. So Montenegro is trying to pick up from that side of things.
Tourism, in particular, higher-end restaurants are needed. I think higher end hotels are needed, and these developments are just discussed as some of them. So as Montenegro proceeds towards maybe a European Union entry, and that’s maybe quite some years away, I think quite a lot of training of youth will also be needed. So there is quite a lot of opportunity there, but it’s just a matter of whether it can be executed or not — the right way. With these frontier markets, Jordan, there’s always quite a lot of risk.
Jordan: Right, now how’s the tax situation there?
Tiho Brkan: Well this is one of the great advantages of Montenegro. Taxes are very low, some of the lowest in Europe, being 9% flat across the board. Meaning corporate taxes, individual taxes, and withholding taxes are all 9%. Now, there is also now rumors and discussions that there is a possibility of an official residence and citizenship program that might occur in Montenegro — where high net worth individuals might be able to purchase a passport. Or maybe similar to Spain, Greece, and Portugal, obtain a tax residency — as they call it a Golden Visa Residency, where they’re exempt from taxes, similar to Portugal, up to 10 years or so from foreign-sourced income. So this is quite interesting, and mixing this with the fact it’s a beautiful place to live, Montenegro is trying to brand itself like a bit of tax haven for higher net worth individuals and maybe instead of Montenegro, they’re trying to become the next Monte Carlo. That’s the way that I feel.
Jordan: Okay Tiho. So with all that being said, what is your final verdict on Montenegro?
Tiho Brkan: I would say that real estate is a tad expensive for me, but there are a few gems that can be purchased depending on hard you do your research. Business opportunities I would expect that most entrepreneurs will not find much, apart from the fact that tourism can be developed tremendously. So I think, looking at foreign direct investment and property development in Montenegro, other foreigners, other extremely wealthy foreigners, their companies, seem to be moving towards that area with development. Porto Montenegro, Portonovi, and Lustica Bay developments are the ones I visited. The final verdict for me, personally, is that I am looking to purchase something for the long run, preferably some land which can be developed or something similar. Foreigners who do purchase land or real estate can obtain a residency card as well, so this is something of interest, and if you tend to spend 183 days or more in this country, you can lower your taxes dramatically.
And purchasing in the right place can earn a very strong rental yield, I think, during the seasonal period from June, July, August, September — summer months — when Montenegro gets absolutely swamped on the Adriatic Coast. So not a lot of opportunities unless you’re focusing towards tourism, but I think in years to come, Montenegro might become more and more of a shining gem.
Jordan: Moving on Tiho, in this week’s global macro segment, we are going to be talking about foreign markets, with a major emphasis on emerging market equities. Now, Tiho, as we get started, what is your general view of equities outside of the US?
Tiho Brkan: Well general view outside of the US right now is that these equities, foreign equities — from the perspective of a US investor — have lagged tremendously, especially since 2011. So there is value to be purchased if the recovery is going to take place. Having said that, the risks remain. Emerging markets, in particular, are very prone to a strong dollar, so we continue to watch these equities because on one hand they’re cheap, and on the other hand they have the potential to move up if the momentum continues. I do favor them a lot over the US equities, which I think currently are fully priced.
Jordan: Now Tiho, let’s step back a second. I mean, obviously emerging markets and other foreign markets have been outperforming this year, but just stepping back, these markets really underperformed the US for more than a few years. Can you say why that happened?
Tiho Brkan: Well, first of all, let me dig a little deeper into the underperformance. Emerging markets outperformed the US at the beginning of the cycle. So a majority of the equities around the world bottomed in March 2009, and emerging markets rallied very strongly into 2011, but in particular peaking in May of 2011. I mean so did the S&P 500 in the US, as well as the Dow Jones. But the underperformance of emerging markets since 2011 has been, in my opinion, closely liked to the underperformance of commodities and the outperformance of the U.S. dollar, which right now still technically remains in the bull market. So as long as the US dollar continues to rally — and that remains a big question — emerging markets could continue to underperform.
Since May 2011, EM performance has been kind of sideways until 2015, at which point we had problems in the Eastern European side of things with Crimea and Russia, and we also had the crash in oil which affected other countries such as Brazil. Commodities also came under pressure, so South Africa went down. And finally, the Chinese stock market bubble of 2014 popped into 2015 and we had quite a catastrophic crash leading into the bottom in January 2016. So quite a lot of underperformance in emerging markets. There’s been quite a lot of risks, but they seem to be coming back now, roaring back over the last 18 months, and the momentum is behind them. So we really have to analyze whether they have more to go, or whether they’ve hit a resistance here, Jordan.
Jordan: You mention momentum, that’s a good segue, Tiho, because I want to know that, as you always tell me, investors should focus on the two key elements, which are valuations and momentum. But we’re going to start with valuations first. How are foreign stocks and emerging stocks especially, how are they priced relative to the US — which we covered in episode one?
Tiho Brkan: Well as I mentioned before, United States I think is fully priced. That doesn’t mean that it cannot get more expensive and get overpriced, but it’s fully priced at the current level. When looking at the S&P 500, for example, the cyclically adjusted price-to-earnings ratio is 31, according to Dr. Robert Shiller, and the price-to-book value I think is a 3.2 for the United States stocks. In comparison to what you just asked me, foreign stocks are priced much more attractively, in particular emerging markets. The CAPE in emerging markets hit single digits in January 2016, which was the low in my opinion, and it’s been rising, but only slowly. So emerging markets are priced very, very attractively — both nominally, in their own terms, as well as in a relatively against the US.
Jordan: Yeah, I think that’s a key point that you’re mentioning: they’re still attractive as far as valuations, and that’s 18 months after what was a major bottom. Now let’s talk about what kind of future returns can investors expect from emerging markets at the current valuations?
Tiho Brkan: Yes, very interesting question. First of all, you said a very interesting point there, Jordan. I remember studying 1982 bottom in the U.S. stocks when cyclically adjusted price-to-earnings ratio hit single digits as well. Despite the fact that U.S. stocks rallied for years, into 1985 let’s say, and they had tremendous gains — US stocks were still priced fairly. And despite the fact that US stocks rallied hard and then crashed in 1987, they still continued to rally into ’88, ’89, into ’90, before the Savings and Loan crisis. At that point, US stocks were still kind of cheap and attractive. It was only until a 10-15 year bull market continued, well into the mid-1990s and the late-1990s that US stocks became extremely expensive.
Looking at the difference today between US stocks and emerging markets, to answer your question; the most attractive developed markets outside of the US, in my opinion, are Austria, Israel, Italy, Norway, Portugal, Singapore, Spain, United Kingdom. A basket of these equities has a CAPE of 14, relatively to 31 for the United States — and that seems to be half price. And also price-to-book value, as a basket altogether, at 1.4 times, which is also more than 50% of that, that you would be paying in the United States.
Moving our attention towards emerging markets, I like countries like Brazil, China, Poland, Russia, South Africa, South Korea, Thailand, Turkey, and even some of the frontier markets. The basket of these emerging market equities has a CAPE of 13, which is even lower than the developed markets I just mentioned previously. And also a similar price-to-book valuation of 1.4, which is more than half of that of United States. I’ve already invested in some of these markets, they’ve done tremendously well in 2017, and I think some momentum is behind them, so we will see if they continue to go higher from here.
Jordan: Okay, I was going to ask you for some specific markets, but you already mentioned quite a few there. Can I pry a little bit and just ask you which ones you favor and which ones you’ve invested in for your clients?
Tiho Brkan: Well, this is particularly for my clients, so if listeners are interested in getting some advice or some wealth management needs, they should come to theatlasinvestor.com, get in contact with me, and we can have a free consultation there and we can start to talk about some investment themes and future plans.
Jordan: Okay, fair enough. Now, we covered valuations, let’s move on and talk about momentum. How is the price of emerging markets been behaving?
Tiho Brkan: Well, as we discussed previously, the emerging markets have had underperformance since 2011 due to the strong dollar. However, Jordan, the truth is that emerging markets have actually had a lost decade. They’ve been underperforming since 2007, so since just before the GFC. They peaked in October 2007, afterward crashing. The recovery took them back to the same peak, the same price level in May 2011, and was later followed once again with a peak in 2014. So they’ve been kind of going sideways. Now emerging markets momentum has been very strong since January 2016, when they found the low and Chinese stock market crash finally bottomed out. They’ve been really on a tear for the last, I think, seven, eight months, not having any kind of a pullback at all. So momentum is very strong and outperforming the rest of the regions around the world, Jordan.
Jordan: Tiho, EEM, the Major Emerging Markets ETF, that’s trading just below 46 as we record this, and if our listeners pull up a 10 or 11 year chart, you can see that there’s this massive base with resistance, kind of in the mid to high forties, so do you think that emerging market stocks are ready to break out now as opposed to a few years ago?
Tiho Brkan: Well, when this resistance was first hit in 2007, the U.S. dollar was extremely underpriced relative to its value purchasing power parity value. And also in 2011, which was the final low in the US dollar, it was also underpriced relative to its value. The interesting thing is that emerging markets equities themselves have gone sideways when priced in US dollars, despite the fact that the US dollar index has had one of the longest and one of the strongest bull markets. So the US dollar is not cheap anymore. At the same time, the earnings in emerging markets have increased quite a lot, and so has the GDP growth of some of these countries. Some of which are growing at, depending on whether we believe the statistics or not, four, five, even six percent per annum. So generally speaking, demographics are better, growth is stronger, earnings are recovering and also growing, while the price is being kind of in a sideways trend.
So despite the fact that we’re trading at the same level as 2007 on the EEM, as you’ve just stated Jordan, the interesting fact is that it’s a totally different situation. Today, US dollar is overpriced, and price to earnings are so low, making valuations for these equities extremely attractive.
Jordan: Okay, Tiho. Now let’s delve a little bit more into momentum as far as relative strength. If you pull up a chart of emerging markets divided by US stocks — and emerging markets divided by the S&P 500 — we can see that there’s a bottom in 2016, another bottom earlier this year in favor of emerging markets. That relationship has trended higher a little bit, but we haven’t seen anything explosive yet, so what’s your view of the relative strength of emerging market stocks as compared to US stocks?
Tiho Brkan: Well I think it seems to be turning, but a lot depends on the US dollar. Like I’ve said, the key remains United States dollar, and whether it will continue its bull market or not. But pulling up that chart, one interesting factor to discuss here, Jordan, is that for the first time since 2010, or even 2011, emerging markets relative to the United States, the relative performance of these two asset classes, we are watching emerging markets make a higher high on the relative basis. So we haven’t seen that since 2010, 2011 period. So maybe that’s a tell that finally, after so many years of underperforming, emerging markets are about to trend upwards by outperforming US stocks for a sustained period, not just a couple of months.
Jordan: Yeah, that’s a good point, and I’ll just add something I really like to use in my work is the 400-day moving average or the 80-week moving average. If you look at a ratio chart — a weekly chart — and you include the 80-week moving average, that moving average from 2011 down all the way through 2016, that pretty much contained almost every rally attempt in the ratio. I mean it may have gone above it here and there, but now we see that earlier this year, the ratio has turned up. It’s made a higher high, as you said, and that moving average is sloping higher, so technically speaking, those are all good things. But with that being said, Tiho, I mean you mentioned the dollar, I know we’re going to talk quite a bit about that in episode three, but what are some of the risks that could derail the current value in emerging markets?
Tiho Brkan: There’s two of them in my opinion. The first one is sentiment and the second one is the US dollar. The sentiment is quite an important thing because whenever we have a bull market, bulls are important because they do the buying, pushing prices higher. But whenever we have too many bulls, prices tend to correct. And at times, too many bulls tend to peak a trend. We saw a peak in an emerging market bull market in 2007 — when we had too many bulls. And also in 2011 when we had too many bulls. The situation is quite similar to today. But having said that, the valuations are not similar today. So we are at a much similar price pattern, let’s say going back to 2004 — then 2007 and 2011 — which I just discussed.
So in other words in 2004, valuations were very low, like today, and the sentiment was very high by global fund managers having a high exposure, an overweight positioning towards emerging markets, just like today. But after a brief correction, emerging markets continued higher, and that’s because the majority of the longer term players, and those that are deep value investors, jumped on board as earnings continued to improve and economic performance continued to expand. So I think emerging markets could be in early stages of a bull market — if the pattern to 2004 holds.
That remains to be seen because the other side of the story is the US dollar. I was fortunate enough to call the bottom and the rebound in the US dollar from extremely oversold conditions going back, I think, on 20th of September 2017 — as posted on my Twitter. And for the listeners, you can find me at @TihoBrkan on Twitter, and from time to time I’ll disclose some of my trades in real-time. So, we now have to watch the dollar very closely, Jordan, because as it rallies, we want to know whether this will be a rally that fizzles out, ends up being a lower high from which the US dollar can roll over and continue to sell off. Or whether this would be another low from which the US dollar bull market will continue.
And if that’s the case, emerging market currencies will feel pressure, and therefore the emerging market equity index that we’ve been discussing in this episode could see a more serious and a more meaningful correction. So the two risks are that fund managers extremely overweight right now, and the US dollar is about to become a headwind, not a tailwind.
Jordan: So it sounds like it’s fair to say, at least the short-term, maybe medium-term here, emerging market stocks, there’s a lot more risk, a risk of a correction. With that being said, Tiho, you’ve covered a lot here already, but anything else you want to add as far as a final verdict on emerging market and foreign stocks?
Tiho Brkan: Well, it’s clear from the interview and discussions that we’ve had here, that my view is that from the longer term perspective, emerging markets have a very strong forward returns. Much higher than US stocks, which are fully priced, and probably will return between 1-2% over the next 10 years. Emerging markets will do much better. But having said that, over the short to medium term, as you just said, emerging markets might experience some headwinds from high sentiment and exposure by the groupthink fund managers — all of whom seem to jump in just after the train has already left. And also the fact the US dollar is now rebounding from oversold conditions — as the Fed becomes a little bit more hawkish. So all worthwhile watching, Jordan.
Jordan: Yes, and as you mentioned, the U.S. dollar will be very important and that’s why I will encourage listeners, please stay tuned for episode three, we’re going to discuss the dollar in quite a bit more detail.
That concludes episode two of The Atlas Investor podcast. Tiho, as far as episode three, where will you be, and what will you be covering?
Tiho Brkan: Well I’ll be traveling from the tourist-friendly Montenegro to a nearby, adjacent Croatian coastline. Croatia recently joined the Eurozone, and it’s a country where tourism is absolutely booming, Jordan. On top of that, we’ll be discussing global currencies, in particular, the United States dollar, which is so important as one of the key indicators for so many asset classes that we’ll be discussing on this podcast.
Jordan: Well Tiho, I’m really looking forward to that. Now as we close, we want to thank you, the listener, for tuning into the podcast. If you have a moment, please visit iTunes and leave a review of the podcast. We would really appreciate it. And if you have a question for Tiho that you would like answered on a future podcast, you can email it to us at podcast at theatlasinvestor dot com. On behalf of Tiho Brkan, thanks again for listening to The Atlas Investor podcast, we hope to have you back again for episode three.
Thank you for listening to The Atlas Investor podcast. To be notified of future podcast episodes sign up for our free newsletter and join our Youtube channel. Tiho Brkan offers his clients a wide range of services. Including portfolio construction and wealth management. One on one consultations. Global real estate opportunities. International tax planning. Citizenship and residency planning. And one on one mentoring. For a free consultation, visit the Atlas Investor dot com and contact Tiho Brkan.