American exceptionalism again
Well, someone came out and said it — the US is in a big, fat bubble. Here is Ruchir Sharma in yesterday’s FT:
Relative prices [of stock in the US] are the highest since data began over a century ago . . . the US accounts for nearly 70 per cent of the leading global stock index, up from 30 per cent in the 1980s . . .
The overwhelming consensus is that the gap between the US and the world is justified by the earnings power of top US companies, their global reach and their leading role in tech innovation. These strengths are all real. But one definition of a bubble is a good idea that has gone too far . . .
America is over-owned, overvalued and overhyped to a degree never seen before.
It is important to emphasise that none of this is a Magnificent 7 phenomenon. Below is a chart of the forward price/earnings valuations of the S&P 500, the S&P 493 (ie the 500 minus the Mag 7), and (just to pick one global example) the S&P Europe 350. Taking out Big Tech makes only a small difference.
Does Unhedged agree with Sharma that the US is a bubble compared to the rest of the world? It sure does. The US is overvalued, possibly significantly. That said, it is not as wildly overvalued as charts such as the one above would suggest, and it would be a mistake to bet on a big convergence between US asset prices and those of the rest of the world in the near term.
Small differences in earnings growth, if they last a long time, make a big difference to what shares are worth. The S&P 493 is currently at a 40 per cent premium to the Europe 350. Expectations on earnings on the former index will grow about 11 per cent over the next year or two; the latter index, about 9 per cent. This may not sound like much. But plug a two percentage point difference in growth rate into the valuation model of your choice, and it can easily justify a valuation difference of a third or so, depending on other inputs such as discount rates — so long as the growth difference is sustained indefinitely.
For the valuation gap to close, something has to happen to make investors rethink that “indefinitely”. With the incoming Donald Trump administration determined to pull every pro-growth lever domestically while imposing tariffs abroad, that does not seem likely in the near term. If and when inflation heats up again, the picture may change. Until then, the US bubble is more likely to inflate further than it is to shrink.