The US economy has been the one real driver of economic growth in the last 12 months. There is hope that this will broaden out, with Europe and emerging markets performing better in the coming 12 months.
One question we often get is - should we move away from US stocks to Europe, China, India, or other emerging markets?
Our short answer is no.
Let’s break down how we get to this conclusion.
At the time of writing the S & P 500 is trading at almost 20 times forward earnings (or PE), against a historical average of 15.6.
If we look at the MSCI all country world index that excludes the US, then the forward earnings multiple is 12.8 times. The gap between the US and the rest of the world is at highs not seen in 20 years.
Part of the reason for this gap is that Chinese equities are at multi year lows. Is now a good time to invest in Chinese equities – we say no but that is not based on valuations. However, we leave that discussion for another day.
One way to explain why the US might have a higher PE is to look at the underlying businesses.
Whilst this can change and noting Meta is currently surging in after hours trading, the largest 5 businesses in the US are:
1. Microsoft
2. Apple
3. Nvidia
4. Amazon
5. Alphabet
Not a bad set of businesses, they are high quality with growing earnings and lots of free cash flow.
Take Microsoft for instance, net income was circa $40 billion in 2020, based on current growth patterns it is on target for net Income of $80 billion with a year or two. So the question is why would you not pay a higher multiple for a business that can achieve results like this?
Let’s take a look then at the five largest stocks in the UK.
1. Astrazeneca
2. Shell
3. HSBC
4. Unilever
5. BP
There are two energy companies and a bank in the Top 5. You would expect to pay a lower PE to buy this market when compared to the US.
If we examine further, the projected growth rates US companies are projected to grow at double the growth rate of European companies. The US economy only relies on exports for 12% of its growth, so as long as the American consumer remains resilient so will the US economy. The more growth you have the better your companies will perform.
Importantly the companies driving the US market have free cash flow that could only be dreamed off twenty years ago. This free cash flow in our eyes justifies a PE premium.
Looking at the broader US market, if we take an equal weighted approach to the US market, the PE ratio’s look reasonable at circa 16 times. So the premium really applies to those companies with a history of growing earnings and cash flow, and an opportunity to now monetise AI going forward.
In summary you have to pay more for quality. The question and analysis that need to be done is not whether the US has a higher PE, but whether the PE discrepancy should change your investment decision. In our view with the state of the economies worldwide the US should outperform and its companies will likely do the same.
We didn’t coin this phrase, but we have embraced it: America Innovates, China Replicates, and Europe regulates.
We have clients who have been waiting for the Australian property market to fall because it looks expensive, the same could be said for US equities, but waiting for them to fall has not been a successful strategy except in a small number of occasions. Just a simple google search for “are US stocks overpriced” will bring plenty of articles of the past years stating a case that they are, yet the US continues to outperform.
If you read our previous article about Artificial Intelligence – the US is best place to take advantages in automation and productivity growth in the next ten years. So whilst we don’t only invest internationally in the US, we are happy to have a strong bias to the US for now.
Please note the views expressed above are for general information purposes only and are not meant to be taken as personal financial advice. You should consult a professional before making any investment decision.
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