Investors love U.S. assets and for good reason. Over the past decade, stocks listed in the United States have thumped their international rivals, producing returns that have been more than twice as high as the payoff from stocks in the rest of the world.
But past performance says little about what lies ahead. The question now is whether Wall Street can continue to be investors’ no-brainer choice for the decade ahead.
To my mind, that seems highly unlikely. Let me offer four reasons why you may want to start reining in your U.S. exposure.
The first is valuation. By global standards, U.S. stocks are now priced at nosebleed heights in relation to their economic fundamentals.
The gap between them and foreign stocks is huge: U.S. stocks trade for 23 times earnings, compared with only 14 times for European stocks. They pay a paltry dividend yield of only 1.2 per cent versus a much more generous 3.2 per cent for Canadian stocks.
Exactly why U.S. stocks are so much more expensive than their international rivals is an interesting question. In some cases, you can point to a technological edge. In other cases, though, the lush valuations on Wall Street seem to reflect nothing more than a general state of giddiness.
Consider the recent excitement over boring old Walmart Inc. Over the past year, the share price of the giant retailer has jumped more than 34 per cent.
Is it plausible that a company as big and mature and perennially well-regarded as Walmart could really be worth a third more than it was 12 months ago? There are excellent reasons to be skeptical. Walmart hasn’t reinvented its business. It’s simply had a bit more luck attracting upscale consumers. Yet at its current valuation of nearly 30 times earnings, it’s priced like a hot growth stock.
To be sure, the exuberance that is carrying Walmart higher seems nearly modest compared with the manic euphoria that surrounds everything to do with AI. The sky-high expectations for artificial intelligence provide a second reason to be cautious about what lies ahead for Wall Street.
A trio of AI-related stocks – Nvidia Corp., Microsoft Corp. and Apple Inc. – now make up more than 20 per cent of the S&P 500 index. All three companies have surged this year because of expectations they will benefit from a mass turn toward artificial intelligence.
The problem is that no one is quite sure how AI will change things – or, for that matter, if it will change things. Jim Covello, head of global equity research at Goldman Sachs, is among the doubters.
In a recent report, he argues that AI is expensive and not as useful in its current state as people think. It still lacks a simple, obvious application that saves time and money for anyone who uses it. Mr. Covello says that if a powerful use case for AI doesn’t emerge before the next economic downturn, AI stocks could have a long way to fall.
Whatever happens to AI, Wall Street is also vulnerable to a quieter, less technical threat: the possibility that the U.S. economy isn’t quite as robust as investors now assume.
Consensus forecasts now see inflation fading painlessly back to target and growth continuing at a decent pace with no recession in sight. Cautious investors, though, may see a third reason to be wary about U.S. stocks if they ponder how much of that happy outlook rests on the federal government’s continued willingness to gush cash.
Washington has essentially been running wartime deficits in peacetime. Its enormous deficits – equal to 6 per cent or more of the economy – are helping to inflate corporate profits for now. However, if markets balk at absorbing the huge amount of debt that Washington is now issuing, deficits may have to shrink – with unpleasant consequences for corporate profits.
Granted, the outlook for the deficit hinges on politics. A final reason to be cautious about U.S. markets is the unpredictable presidential election in November.
As things now stand, a convicted criminal will face off against a fading codger. Neither seems like a good option, but if Donald Trump is elected, markets will have to confront substantial uncertainty over whether he will follow through on his promises to erect new barriers to trade and demolish much of Joe Biden’s industrial strategy and climate policies.
Investors may want to take a step back from this turmoil. For all its current high spirits, the U.S. stock market is an expensive, politically volatile place that is riding high on AI euphoria and big deficits. Now is a fine time to start moving a bit of money into cheaper, less frothy markets.