Is the US starting to look overvalued?


Investors are flocking to US equities in the current low-growth environment but as ratings continue to rise on the back of the country’s brighter economic prospects, is the US stockmarket beginning to look overvalued? 

This year has so far seen the S&P 500 hit multi-year highs and despite suffering a period of increased volatility following concerns over the Federal Reserve’s plans to end quantitative easing, it is still up by about 19 per cent year to date.

In its most recent World Economic Outlook update, the International Monetary Fund predicted that the US will grow by 1.7 per cent during 2013, which is higher than the expansion being seen by the rest of the developed world.

Rathbones chief investment officer Julian Chillingworth says: “Where are you going to see any growth in the near term? In the US. 

“In the short term, the market is fully reflecting the fact that investors are looking round the world and thinking about where they are going to put their money. 

“They have pushed money into the US, which is driving up the ratings.” 

According to the latest monthly fund manager survey from Merrill Lynch, June saw allocations to US equities rise to their highest levels in 13 months, with a net 25 per cent of asset allocations now overweight the country.

Investors initially put their money into defensive sectors such as utilities and consumer durables, making these areas of the market very expensive, according to Chillingworth.

JP Morgan US Select manager Susan Bao says her fund remains underweight stocks with “rich valuations”, due to high dividends such as utilities, Reits, consumer staples and defensive contractors. 

She says: “Unsurprisingly, those stocks have suffered the most in the last few weeks. And those sectors still look expensive.” 

Old Mutual Asset Management head of quantitative strategies Ian Heslop says although he remains generally positive on the US after signs of improvements in the housing market and GDP forecasts, valuations may be stretched.

He says: “If you look historically on the US market, there is not much juice left in the price-to-earnings ratios. 

“You would have to see earnings or revenue growth but margins are already reasonably and structurally high. You would then have to believe margins are going to expand further, which is quite tricky to argue.”

Charles Stanley head of investment research Ben Yearsley says: “I don’t think the US is expensive. Valuations are up there but that is because people expect growth to come through. 

“Shale gas is huge, companies are taking manufacturing back to the US, the housing market is recovering and jobless numbers are falling.”

Yearsley adds the US has historically nearly always traded at a premium compared with other developed markets, in particular the UK.

Others are now looking to explore opportunities where value can still be found in the US market.

Chillingworth says: “People have been switching out of defensive stocks and into more cyclical areas such as industrials and materials. These companies are more lowly rated and investors are playing the theme that if the economy is improving then these cyclical companies will do better.”

Bao also has a “pro-cylical tilt” to her portfolio, with the fund’s biggest overweight in semiconductors such as Lam Research and Applied Materials.

She points to opportunities for growth in autos and housing-related stocks as well as financials including Wells Fargo, Citigroup and Bank of America. She adds: “These earnings have room to improve as losses shrink and interest rates rise.” 

Bao acknowledges some uncertainty hangs over the US equity market, with the potential of a knock-on impact from the Fed’s plan to gradually taper QE. However, she is confident the market can continue to rise.

She says: “We recognise the downside risk of rates rising too quickly and there-fore potentially negatively impacting growth but our bias remains towards a market trending higher, driven by economic recovery.”

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