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Have U.S Stocks Become Too Expensive?

Addressing the question from a global perspective.

John Rekenthaler, 06/23/2017

I had intended to rebut Ben Johnson's "Home Bias Blues" article, in which he argues that U.S. investors should hold more foreign securities. There are valid reasons for dining in, which I planned to raise. However, Ben acknowledges those arguments and counters them effectively. So … I agree with his column. This article will be no Point/Counterpoint

However, I do wish to examine one of Ben's side points, which is that now is a particularly good time to look elsewhere, because U.S. stocks have become unusually costly relative to their peers. Ben brandishes a chart, courtesy of Research Affiliates, showing that that U.S. stocks are now relatively expensive, while other countries' stocks look to be cheap. The obvious conclusion is to favor the latter over the former.

Yes and no. The "Yes" argument is straightforward: Research Affiliates is a reputable firm, and that chart's data makes a compelling claim.

Another Angle
For the "No" argument, let's observe a different view of global price/earnings ratios purloined from provided by Yardeni Research. This graph takes a regional rather than country perspective, sorting the world into three categories: non-U.S. developed markets (MSCI EAFE Index, in blue), emerging markets (green), and the United States (yellow). The red line then combines the other three lines to illustrate the MSCI All Country World Index.

  - Source: Yardeni Research

That red line looks odd. In theory, it blends the yellow, blue, and green lines, yet only the first two seem to matter. No matter where the green line is drawn, the red line lands midway between the yellow and blue. This occurs because, despite their huge populations and land masses, the emerging countries remain a small slice of the global stock market. The money--and corporate profitability--is not yet where the people are.

The green line of emerging markets currently falls well below U.S. levels, but that's nothing new. The emerging markets were even further behind in 2001. Which provides a useful test. If Ben's thesis is correct--that countries with lower-cost stocks offer higher future returns--then the emerging markets should have outstripped the U.S. since 2001.

is vice president of research for Morningstar.

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