The US equity market went from strength to strength in 2024 as investors’ hungry appetite for growthy technology stocks sent the S&P 500 soaring 28.4% throughout the year (as of 18 December).
But as US equites leap to new heights, some asset managers grow concerned that a bubble is forming and better opportunities can be found in cheaper markets elsewhere.
Share prices in the US are trading at a lofty price-to-earnings ratio of 26.3 (as of 30 September), which is considerably above some other equity markets around the globe.
‘The most attractive developed market’
It is for this reason that Morningstar’s chief research and investment officer Dan Kemp is taking some focus away from the steep US equity prices and looking towards the relatively undervalued European market.
“After their rally earlier this year, the valuations for US stocks now appear expensive based on our models and top-down expected return estimates,” he said. “By contrast, Europe, and in particular the UK, stands out as a region where investors can achieve better risk-adjusted returns.”
The region’s rising GDP, falling inflation, and lowering interest rates makes it “the most attractive developed market” to invest in currently, according to Kemp.
He estimates that European equities are trading at a 5% discount to their fair value, which is “not cheap, but equally not expensive given where markets have traded over the past few years”.
To find truly cheap opportunities in Europe, Kemp said investors should look to small-cap companies, which are trading at a hefty 40% discount to their fair value estimate. This is where the “significantly greater value” in Europe lies, he said.
Maximising income
Fund managers chasing high returns in the US has also slashed the level of income that investors can earn on their savings, according to Van Lanschot Kempen’s head of the dividend and value team Joris Franssen.
He said 70% of global income funds now have exposure to the magnificent seven stocks – none of which offer a dividend yield above 1%.
“Over the past five years or so, the median yield of global dividend funds has taken a notable tumble, partly due to the fact that many strategies have shifted towards the US,” Franssen added.
“As equity markets reach extreme levels of market concentration, diversification becomes even more important. Valuations are currently more attractive, and yields are higher, outside the well-known US large-cap names.”
To find higher yields and lower prices, Franssen has looked past the US and towards Asian equity markets for new opportunities.
He highlighted Japan and South Korea as two hotspots in the region that are “unlocking significant value” for investors, namely due to the corporate governance reforms that are transforming their equity markets.
Heightened demand in emerging markets
The chasm between US valuations versus the rest of the world is prevalent across different asset classes too. Emily Foshag, manager of Principal Asset Management’s Global Sustainable Listed Infrastructure fund, said she has been allocating away from the US and towards more affordable holdings across the globe within her sector.
“Our view of relative valuation is generally driving us to express a preference for investments outside the US,” Foshag added. “We see infrastructure companies with comparable or even stronger fundamentals trading at material discounts to their US counterparts.”
Foshag underlined emerging markets as not only an area with lower starting valuations, but also much higher growth opportunities.
Rapid urbanisation, population growth, and government-led initiatives to improve infrastructure makes the structural trends there all the greater than developed countries.
Foshag added: “We are seeing meaningful valuation discounts in places like China or Latin America that have the potential to revert over the medium-term.
“More generally, a globally diversified infrastructure portfolio not only reduces reliance on US market performance but also provides a return opportunity that historically exhibits lower correlation to broader global equities.”
This article first appeared in our sister publication, Portfolio Adviser.
