Stocktake: Rising US valuations may hurt long-term returns

Expensive markets can become more expensive in the short-term

A trader makes a phone call outside the New York Stock Exchange. Photograph: Johannes EISELE/AFP via Getty Images

A trader makes a phone call outside the New York Stock Exchange. Photograph: Johannes EISELE/AFP via Getty Images

 

Rising stock prices in the face of declining earnings means US valuations are on the rise. The Russell 1000’s price-earnings ratio is up over nine points from its March lows, notes FTSE Russell’s Philip Lawlor, “far outdistancing the average five-point gain for its developed peers”.

It trades on 23 times estimated earnings – near a 15-year peak and way above most developed markets, which trade on 15–16 times earnings. Other metrics, like the cyclically-adjusted price-earnings (Cape) ratio used by long-term investors, show “an even wider rift between the US and the rest of the world”, cautions Lawlor. Valuations are also concerning index fund giant Vanguard, which last week forecast US stocks would average annualised returns of 4 to 6 per cent over the next decade, compared to 7 to 9 per cent for global stocks.

That echoes a recent Goldman Sachs forecast, which predicts US stocks will generate annual returns of 6 per cent over the next 10 years, well below historical norms. Expensive markets can become more expensive in the short-term, of course, but don’t be surprised if rising valuations dent long-term returns.

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