Are US shares that much over-val­ued?

The Sunday Telegraph - Money & Business - - Money - James Con­ning­ton

Last week, Ap­ple, the world’s big­gest busi­ness by mar­ket value, soared again as it an­nounced a surge in earn­ings and sur­prised an­a­lysts with ex­cel­lent sales across even its older mod­els. The re­sults came just as the iphone X – al­ready at­tract­ing rave re­views – went on sale in se­lected world mar­kets on Fri­day.

Ap­ple’s share price is up 55pc over the past 12 months and has grown six­fold in a decade. With a mar­ket value now ap­proach­ing $1tril­lion (£760bn), dra­matic move­ments in the price of tech gi­ants like Ap­ple can dis­tort the en­tire mar­ket.

And the S&P 500 in­dex of the big­gest com­pa­nies is ris­ing fast, up 15pc so far this year.

Ap­ple, Face­book, Mi­crosoft, Al­pha­bet (trad­ing name for Google) and Ama­zon are the five largest US com­pa­nies by mar­ket value. Be­tween them, they make up around 14pc of the S&P 500.

The av­er­age share price gain of the five firms so far this year is 43pc – Face­book has risen the most, at 56pc, and Al­pha­bet the least, at 32pc. Every fresh surge trig­gers anx­i­ety about whether val­u­a­tions are now un­jus­ti­fied, and due to cor­rect, with some con­fi­dently pre­dict­ing a crash.

But how “ex­pen­sive” is the mar­ket? On one pop­u­lar val­u­a­tion met­ric, Cape – which com­pares a cur­rent share or mar­ket price to av­er­age earn­ings over 10 years, ad­justed for in­fla­tion – the only two points where the mar­ket has been more ex­pen­sive were dur­ing the build-up to the 1929 Wall Street crash, and the tech bub­ble which burst in 2000.

The av­er­age Cape mea­sure since 1881 is 17, but to­day it stands at 31. How­ever, to­day’s Cape ra­tio en­com­passes the past 10 years’ earn­ings, in­clud­ing the global fi­nan­cial cri­sis, when earn­ings fell dra­mat­i­cally. This de­presses the av­er­age earn­ings fig­ure and so re­sults in an ar­guably in­flated Cape read­ing.

This year the earn­ings of Amer­i­can com­pa­nies have been strong, with around three-quar­ters of S&P 500 firms beat­ing ex­pec­ta­tions. Even so, ratios of price to earn­ings are well above the mar­ket’s his­tor­i­cal av­er­age.

A sim­ple price-earn­ings ra­tio (p/e), which takes only the lat­est

‘The mar­ket has been this ex­pen­sive only twice – ahead of ma­jor crashes’

earn­ings fig­ures into ac­count (rather than the past 10 years as with Cape), comes in at 22 – again higher than the long-term av­er­age.

How­ever, when the level of the S&P 500 is viewed over the ul­tra-long timescale of 90 years, the mar­ket is not far above its long-term trend. The graph be­low takes mar­ket data from the past nine decades and presents it as a straight trend­line.

The global fi­nan­cial cri­sis pushed it well be­low this longterm trend, and the re­cent run has largely brought it back in line. It has not yet di­verged sig­nif­i­cantly above trend, as it did in the years ahead of the tech­nol­ogy bub­ble.

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