Are US shares that much over-valued?
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.