Global Economy: Is it time to ‘just say no’ to the US stock market, the most overvalued in the world?- by Proinsias O'Mahony

A record number of fund managers believe global equities to be overvalued, with an overwhelming majority seeing the US market as the most overvalued in the world. Is it time to “just say no” to the S&P 500?

The “just say no” message refers to the title of a new white paper co-authored by high-profile GMO strategist James Montier. GMO, headed by iconic investor Jeremy Grantham, has $77 billion in assets under management and is famous for having predicted past market crises, such as the Japanese bubble that burst in 1989 as well as the 2000-02 dotcom implosion and the 2008 global financial crisis. 

The title of Montier’s latest paper sounds like an anti-drugs warning, and the content of the paper is similarly stark.

Those US gains have been largely driven by an expansion in profit margins and valuation multiples to historically lofty levels. Future gains, says Montier, require either that dividends and earnings start growing at a much faster pace – unlikely, as both are “remarkably stable” over time – or that valuation multiples and margins continue to expand. 

“The historical record for this assumption is quite thin, to put it kindly,” says Montier. Margins and multiples tend to revert to the mean over time, so buying US stocks “now requires a belief that ‘it’s different this time’ with respect to the valuations that people will put on stocks, and the margins that companies can command”. 

The S&P 500, Montier notes, has “trounced the competition” over the last seven years. It has risen 173 per cent, compared to just 71 per cent (in dollar terms) for the MSCI EAFE, the most widely-followed index tracking non-US developed markets. Emerging markets lag even further behind, rising just 30 per cent over the same period.

Still, while Montier’s bearish message may be an especially blunt one, he is far from being a lone voice on the subject of US valuations. Out of 20 valuation metrics tracked by Ned Davis Research, 16 suggest US stocks are extremely overvalued. As noted earlier, Merrill Lynch’s latest fund manager survey shows a record number see global equities as overvalued, with concerns largely centred on the US investment universe. 

The last time fund managers were nearly as concerned was back in the late 1990s. Goldman Sachs recently cautioned that 10-year returns have been negative or below historical norms 99 per cent of the time when valuations were as high as they are today. Vanguard founder John Bogle, who has spent his life preaching the buy-and-hold message, estimates the US market will be hard-pressed to deliver annualised returns of more than 2 per cent over the next decade. 

While there is broad agreement that US stocks are overvalued relative to history and that low future returns are likely, most observers agree valuation cannot be used as a timing tool. An expensive market is not necessarily ripe for a fall; it simply means future long-term returns are likely to be disappointing. Rather than selling, concerned commentators like Robert Shiller suggest investors rotate into non-US markets or underweight the US in their portfolio.

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