US equities have rallied strongly in the wake of the financial crisis to reach ever new all-time highs. FE Analytics shows the S&P 500 has gained 106.71 per cent over past five years, although progress has slowed over the course of 2014 so far.
But the latest CFA UK Valuations Index shows 55 per cent of professional investors now view developed market equities as being overvalued, up from 49 per cent in the previous quarter and 39 per cent at the start of the year.
Furthermore, just 12 per cent of investors see any value left in the asset class - the lowest proportion on record.
Performance of index over 5yrs
Source: FE Analytics
CFA UK chief executive Will Goodhart said: “In spite of serious geo-political events, stock markets are at or close to highs. However, our research indicates that investors are increasingly cautious about valuations and this may affect the way that capital is allocated over the remainder of the year.”
Not all professional investors are convinced that US equities look expensive, noting that some common valuation metrics indicate it is cheaper than perceptions would suggest.JP Morgan Asset Management chief global strategist David Kelly (pictured) points out that the S&P 500 has a forward P/E ratio, using operating earnings, of 15.1 times. This is below the index’s 25-year average of 15.6 times.
Additionally, the forward earnings yield on US stocks is 6.6 per cent, which is 1.8 per cent higher than the prevailing yield on Moody’s Baa bonds. The 25-year average here is -0.7 per cent.
Kelly concedes that some metrics, such as the Shiller P/E ratio or price/cash flows, are looking “a little more expensive” than average. However, examining a broader range of measures suggests the US large caps are at close to average valuations.
“But why does the stock market feel expensive even though, by the numbers, it isn’t,” he continued.
“Part of the problem may lie in the length and strength of the market rally. Since hitting a low on 9 March of 2009, the S&P 500 index has risen, with few major corrections, for five years and five months. Instinctively, this feels like too much of good thing.”
Kelly notes that this rise in the S&P 500 over this time has come alongside a 113 per cent increase in operating earnings per share, which have moved from $13.81 in the second quarter of 2009 to an estimated $29.37 halfway through 2014.
“P/E ratios in early 2009 were exceptionally low reflecting the panic of the times. Because of this, a surge in earnings and a moderate revival in P/E ratios have combined to produce sizzling market returns without actually making the market expensive,” he added.
Harwood Capital chief investment officer Richard Philbin agrees that the US stock market does not look especially expensive, even though it is no longer particularly great value, and highlights the stock-picking opportunities available.
He says technology and biotech as being two areas of the US market looking overvalued, but claims others such as utilities are much better value.
“Whenever you’re looking at averages you’re going to have some areas which are more rich and others that are cheap - irrespective of whether we’re in a bubble or bust period,” he said.
“However, you tend to buy stocks not the market - it’s a market of stocks rather than a stock market. Therefore, there are still potential opportunities in a number of sectors.”
Philbin gets his single country exposure to US equities through the £1.7bn Legg Mason ClearBridge US Aggressive Growth fund. Managed by Evan Bauman and Richie Freeman, the fund is currently first quartile in the IMA North America sector over one, three and five years as well as over shorter time frames.
Performance of fund vs sector and index over 5yrs
Source: FE Analytics
Philbin said: “Although it’s called Aggressive Growth, its portfolio turnover is about 5 per cent a year so it’s not actually an aggressively managed portfolio.”
The fund’s largest sector weighting is to healthcare, where it has a 32.84 per cent allocation. It also has 22.97 per cent in information technology, 12.84 in consumer discretionary and 12.57 per cent in energy with 11.75 per cent in cash.
Harwood Capital also gets US exposure through global vehicles such as Terry Smith’s £2.1bn Fundsmith Equity fund.
This has 61 per cent of its portfolio in US equities, with names such as technology giant Microsoft, medical technologies firm Stryker and soft drink company Dr Pepper Snapple appearing in its top 10.
Philbin adds that the US market might be reaching new highs but this means it is still only at the point it was before the crisis and has room to move further.
“Stock markets die of recession, inflation and external shocks.Is recession going to happen in the US? I can’t see that happening any time soon. There’s very low interest rates but I can’t them going to ‘normal’ levels in this cycle,” he said.
“There’s actually plenty of scope for economic growth and therefore plenty of scope for the market to grow. P/E ratios where they are now are still behind the levels we’ve seen in previous markets.”
