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26 September 2018
By Daniel White
By any measure, the US stockmarket has enjoyed a remarkable run since its financial crisis nadir. By some measures, the protracted period of rising share prices since 2009 has been the longest US ‘bull market’ in history.
The benchmark S&P 500 index of the largest US-listed companies has continued to hit new all-time highs. Many market commentators and investors unsurprisingly question how much longer this will continue, and whether US shares have become overvalued.
There are inevitably parts of the market that look too expensive, but I would not describe today’s US stockmarket as a ‘bubble’. By one headline measure, comparing share prices to projected profits per share, S&P 500 valuations are much less ambitious than during the technology bubble of the late 1990s.
Instead, I would characterise the US stockmarket today as a ‘rubber band’.
The past decade has clearly rewarded investors in the US, but the spoils from rising share prices have not been shared equally.
Investors who adopt a ‘value’ approach – focusing on opportunities among less highly valued stocks – have generally not fared as well as investors in companies that are perceived to offer more stable earnings and growth. While these ‘quality’ stocks are, by definition, more highly valued in the first place, their shares have continued to rise more than those of ‘value’ stocks.
There are several reasons why these share prices have continued to be bid up. Firstly, I would argue that investors generally have favoured companies perceived to carry a lower risk of disappointment or failure. An overlapping preference has been for stocks offering steady levels of income – so-called ‘bond proxies’ – at a time of very low interest rates.
More recently, large technology companies like Amazon and Microsoft have driven the US stockmarket’s gains. These companies are widely considered to have attractive prospects and have become very popular investments – with share prices that reflect expectations of sustained future growth.
Being in vogue, the share prices of more highly rated US stocks have diverged further from those of out-of-favour companies. Today, the valuation gap between the cheapest and most expensive ends of the US stockmarket is at its highest in 30 years.
In this respect, I believe the ‘rubber band’ – this valuation gap – is looking very stretched.
Every bull market eventually runs out of steam when investor optimism weakens, and asset prices readjust accordingly.
By no means am I suggesting the US stockmarket will turn – my medium-term outlook for US equities is broadly positive, in fact – but we should be mindful of the potential challenges and uncertainties that loom large. The Federal Reserve is raising US interest rates, while inflation and tariffs could push up prices for American consumers and narrow US companies’ profit margins.
If there is any shift in investor sentiment, for whatever reason, I believe those stocks with ambitious valuations will be more vulnerable to falls. By contrast, where a rosy future is not baked into a company’s share price, it should logically be less affected by any change in market outlook.
Of course, the value that a company’s shares might offer will depend on its individual merits. Many stocks are unloved for good reason, but, in my view, others are unfairly shunned. It is where a company’s prospects are under-appreciated by most investors that there can be long-term opportunities for value investors, in my opinion.
It is always a good time to question common assumptions. I believe today’s ‘rubber band’ valuations in the US stockmarket should give investors pause for thought.
Please remember that past performance is not a guide to future performance. The value of investments will fluctuate over time, and you may not get back the original amount you invested. The views expressed in this document should not be taken as a recommendation, advice or forecast. We are not able to give any financial advice. If you’re at all unsure about the suitability of your investment, please speak to a financial adviser.