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Is the US equity market overvalued?

This article is part of
One year of Trump: A guide to investing in the US

Is the US equity market overvalued?

Global stockmarkets remained buoyant in 2017 and none more so than the US equity market, which remains in a multi-year bull run.

The S&P 500 index was on a winning streak last year, defying critics who thought the first year of Donald Trump’s presidency would hail a period of volatility for stocks.

Instead, the index delivered total positive returns, when dividends are included, every month in 2017, according to FT.com.

Seven Investment Management (7IM) reveals Mr Trump’s first year in office was the first calendar year in the history of the S&P 500 with no negative months – a statistic that President Trump would no doubt take credit for.

But he probably wouldn’t be so keen to admit while the index has climbed steadily since he took office, it has not performed as well as it did under former president Barack Obama’s first year.

The S&P 500 was up 19.97 per cent since Mr Trump’s inauguration on 20 January 2017, until the end of December 2017, but 7IM points out this is “a long way short” of its performance during Mr Obama’s first year, when the index was up 44.73 per cent.

But the S&P 500 saw an even more impressive run of performance during Bill Clinton’s presidency, research by 7IM shows, who presided over a 263.25 per cent rise in the S&P 500 during his term in office – an annualised return of 17.49 per cent.

Although the S&P 500 has reached impressive highs under previous presidents, investors have been displaying caution about how much further US equities have to go and whether the low volatility environment signals a market correction is due.

Looking beyond valuations

Ritu Vohora, equity investment director at M&G Investments, believes valuations across the Atlantic do look stretched, trading as they are at levels not seen for 20 years.

She attributes much of the rise to multiple expansion, rather than earnings growth and flags that this raises questions about sustainability.

“There are also other anecdotal warnings signs – M&A is at high levels, headline unemployment is very low and interest rates are rising,” Ms Vohora warns. 

“At the sector level, contrary to popular belief, tech is not the most expensive sector, mainly because the strong returns over the past few years have been followed by strong earnings. Energy is the most expensive, as earnings have declined for the past five years contributing to the high P/E [price to earnings] levels.”

In spite of the market as a whole looking expensive, she believes there are factors which “argue for an upward grind higher”.

“Headline growth rates of US corporates continue to surprise to the upside, with mid-teens growth achieved for the total market. Furthermore, following a long period of underinvestment in traditional capital equipment since the GFC, US corporates are beginning to increase spending again on capacity; this will fuel growth.