Chase Vacuums not Bubbles Markets regained their composure last week as the threat of a Greek tragedy diminished. While there are a couple of mile markers before the Greek election on June 17, markets will remain anxious until the ballots are cast.

For the moment, the environment closely resembles the third quarter of last year, with U.S. large cap dividend paying stocks absorbing fearful capital at the expense of everything else.

This “risk-off” trade dominated 2011 and has re-asserted itself forcefully since March. However, bubbles know no bounds and can form in any asset that draws over-allocation, be they tech stocks, financial stocks, gold, Treasuries or U.S. large cap dividend paying stocks. But remember, true durable investment returns come not from chasing bubbles, but from chasing vacuums.

In June 1932, the U.S. was in the deepest throws of the Great Depression. In Chicago alone 42 banks collapsed. Shortly after, Washington politicians vilified bankers as parasites that needed exterminating. Sound familiar? In 1932, 32,000 companies went out of business and unemployment hit 25 percent. The stock market lost nearly 90 percent of its value between September 1929 and June 1932.

As the nation peered into the abyss, the normalized P/E on the U.S. stock market hit an all time low of 4.77. How much would you like to buy?? Had you purchased index shares in June 1932, over the next five years, not including dividends, your investments would have appreciated 28 percent annually; $1 million dropped into the market in 1932 would have become nearly $4 million by 1937.

In the big game of investing, what is most determinant of future investment returns is not which party is in charge, what the economic growth rate is, what war may be imminent or which country may default. What is most important is entry point valuation. Using S&P 500 historical data, here are 10-year annualized returns following different entry point P/Es.

Clearly, lower entry point P/Es correlate with higher long-term returns. Now let’s tour the planet and take inventory of current entry point valuations. Greece: 4.4, Spain 6.6, France 9.6, Hong Kong 11.3, Germany 14.5, China 15.9, U.S. 16.7. The world changes when you look at it this way, doesn’t it? If I told you that you had to pick one of these markets to invest in for the next 10 years and you couldn’t touch the money until 2022, which would you pick?

By the way, this “hold your nose” logic extends to stocks as well. According to the Brandes Institute, after grouping U.S. stocks into 10 deciles by value characteristics, between 1980 and 2010 the lowest valuation stocks outperformed the highest valuation stocks by 575 percent. What makes valuations for countries or companies low today are the despondent appraisals applied; what makes their returns higher tomorrow is that things are rarely as bad as we expect them to be.

David Waddell, who is regularly featured in the Wall Street Journal, USA Today and Forbes, as well as on Fox Business News and CNBC, is president and CEO of Memphis-based Waddell & Associates.