What’s Going On Here?The CEO of investment bank Goldman Sachs warned last week that US stocks are getting too hot to handle as high prices remain unsupported by companies’ actual earning potential. What Does This Mean?When assessing how pricey a public company is, analysts like to compare its share price to its earnings per share: annual profit divided by the total number of shares outstanding. When the resulting “price-to-earnings (P/E) ratio” is low relative to competitors, it suggests a company’s stock is cheap – and when it’s high, the shares look more expensive.
Record-low interest rates and unlimited central bank support have pushed investors in search of returns head first into stock markets, with hot competition pushing up prices. And with company profit predictions now drastically lower thanks to the pandemic, US stocks’ P/E ratios have risen rapidly. Assuming the 190 worried investors surveyed by Bank of America this month are a representative sample, it’s likely that portfolios will soon be rebalancing away from US stocks. Why Should I Care?For markets: World: hold on.
US stocks’ almost 40% rise from March lows sent their “valuation premium” – how much higher the average P/E ratio is compared to other markets – up to four times earlier this month, compared to the historical range of between zero and two. But the ‘Murican premium has already started closing almost as quickly as it opened up. Given US stocks have remained pretty popular, that primarily reflects investors’ purchases of more stocks elsewhere: Germany, South Korea, Brazil, and South Africa have recently caught investors’ eyes, to name but a few.
For you personally: Keep calm and carry on diversifying.
Valuations oscillate over the years, and what’s expensive in 2020 might be seen as a bargain by 2021. That’s why for most individual investors chasing individual groups of stocks might be more trouble than it’s worth. After all, a globally diverse portfolio should benefit from rising markets all over the world. | 