Stocks in certain sectors have rallied hard on the presumption that they’ll be beneficiaries of lower taxes and less regulation under the new administration. As a result, valuations in many segments of the U.S. equity markets are stretched. Should investors be concerned?
What to Know
U.S. stock valuations are creeping upward
U.S. stock indices have reached new highs since the U.S. presidential election. The S&P 500 Index has reached its third highest CAPE ratio peak since 1920, surpassed only by the dot-com bubble of 1999 and Black Tuesday in 1929. This ratio indicates that the stock index’s price (driven by investor expectations) is elevated relative to actual historical earnings.
Are Investors Driving Up Valuations?
S&P 500 Index Cyclically Adjusted Price-Earnings (CAPE) Ratio
Stocks Seem Expensive, but Look at the Big Picture
The “Fed model” shows relative valuations of stocks and bonds by comparing the earnings yield of the stocks in the S&P 500 to the 10-year Treasury yield. Currently, earnings yields are higher than Treasury yields, meaning stocks are cheaper than bonds. So despite historically high CAPE ratios for stocks, they are still attractively positioned versus bonds. Investors should keep this in mind before making allocation changes from stocks to bonds.
Fed Model Says Stocks Are Cheaper Than Bonds
Where to Look
Consider Looking Beyond the U.S. for Better Valuations
For investors who want to keep their allocations to equities but are nervous about current U.S. stock valuations, one option is to seek opportunities outside the U.S. Price to earnings (P/E) ratios for emerging markets (EM) and developed markets (DM) are significantly lower than the U.S.
EM stocks in particular appear attractively priced. Although EM stocks have rallied since the beginning of the year (on top of a positive year in 2016), they are still below their 2013 peaks. EM assets are benefiting from the fading risks of new policies coming from the U.S. administration that could disrupt trade, as well as from a pick-up in global business activity and confidence.
Looking ahead, we expect emerging markets will continue to benefit from the current global environment as long as the risks associated with developed market politics and policies are contained.
For more information about emerging markets, visit our websites or call us:
- Individual Investors: 1-800-345-2021
- Intermediary Investors: 1-800-345-6488
- Institutional Investors: 1-866-628-8826
International investing involves special risks, such as political instability and currency fluctuations. Investing in emerging markets may accentuate these risks.
Investment return and principal value of security investments will fluctuate. The value at the time of redemption may be more or less than the original cost. Past performance is no guarantee of future results.
The opinions expressed are those of Nathan Chaudoin and are no guarantee of the future performance of any American Century Investments fund. This information is for educational purposes only and is not intended as investment advice.