Why Pricey US Stocks Will Avoid a Meltdown

Versus other major markets across the globe, U.S. stocks trade currently trade at their biggest valuation premium in at least 40 years, aside from the dotcom bubble era of the late 1990s, creating big concerns among many investors. Nevertheless, there is compelling evidence that U.S. stocks are not overpriced, and thus not in danger of a meltdown, for two major reasons, argues a column in The Wall Street Journal: compared to much of the rest of the developed world, the U.S. is considerably stronger economically and has a significantly larger share of the fastest-growing large companies.

Indeed, two of the market's most esteemed gurus also do not see cause for alarm right now. Nobel Laureate economist Robert Shiller indicates that U.S. stocks are expensive, according to his widely-watched CAPE ratio valuation model, but he sees no signs of a bubble, Barron's reports. Neither does billionaire hedge fund manager Leon Cooperman of Omega Advisors. "As much as I think the S&P [500 Index] is adequately valued, I'm finding a lot of companies that are very attractively priced," Cooperman told Business Insider. "Market cycles don't end at fair value; they end at overvaluation," he added.

Key Takeaways

  • U.S. stocks are valued at a premium versus other developed markets.
  • This premium is at a 40-year high, excluding the dotcom bubble era.
  • Bulls say that higher U.S. economic growth justifies the premium.
  • Also, big high-growth companies tend to be concentrated in the U.S.

Significance For Investors

Given that the U.S. economy is growing more briskly than other developed economies, companies listed in the U.S. have an additional advantage over rivals domiciled abroad, per the Journal column. Earlier in 2019, Morgan Stanley estimated that the U.S. market provides 69% of the revenue reported by U.S. companies, versus less than 20% for European and Japanese firms. In other words, U.S. companies have about 3.5 times more exposure to the world's largest and healthiest economy, unlike their key rivals.

To assess the relative valuations of U.S. stocks compared to those in other developed markets, the Journal column cited analysis by financial data and technology provider Refinitiv, which looked at forward P/E ratios and price to book (P/B) ratios. The other developed markets in the analysis were the eurozone, the U.K., and Japan. The analysis of P/B also included emerging markets and found that the valuation premium for U.S. stocks right now is the highest that it has been since at least 1980, outside of the dotcom bubble period, when it was even higher.

The analysis of forward P/E ratios also drew comparisons with the MSCI All Country World Index, excluding U.S. In six of ten industry sectors, U.S. stocks were the most expensive: financials, consumer discretionary, communication services, energy, utilities, and materials. In three others, information technology, consumer staples, and industrials, U.S. stocks were very close to being the most expensive. Only in health care did U.S. stocks come close to the bottom in valuation. Real estate was excluded since valuations arguably are hard to compare across countries.

Info tech and communication services, the column notes, are dominated by fast-growing mega cap U.S. companies, most notably those often grouped as the FANG stocks. These are Facebook Inc. (FB), Amazon.com Inc. (AMZN), Netflix Inc. (NFLX), and Google parent Alphabet Inc. (GOOGL). The rest of the developed world has few companies of similar scale and growth potential, the column notes.

Looking Ahead

Billionaire investing guru Warren Buffett of Berkshire Hathaway also has said in the past that the ratio of the S&P 500 Index to U.S. GDP is "probably the best single measure of where valuations stand," per previous reports. Earlier this year, Buffett indicated that he was still comfortable holding U.S. stocks, despite high valuations.

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