Are American stocks too expensive?
American stocks are expensive – really expensive.
The way analysts measure how expensive stocks are is looking at the ratio of their price to the company’s annual earnings.
Goldman Sachs has calculated that even excluding the largest technology companies, US market valuations are at a 20-year peak, currently sitting at a ratio of 19.3 price to earnings ratio, compared to a historical average of around 15.
With big tech included, this comes to 22.2. The S&P 500, the 500 largest companies in the US, currently sit at 29.1. The tech-focused Nasdaq is at 45.4.
In contrast, most equity markets are averagely valued relative to history, with the UK sitting at 11.4, lower than emerging markets, Europe as a whole, and Japan. Only China is cheaper, at 9.9 times price to earnings.
US stocks now make up more than 70 per cent of the MSCI World Index, which tracks all stocks worldwide, the highest proportion since 1970.
This stock market exuberance over the last couple of years has boosted the price of some American stocks to mind-boggling highs.
For example, Nvidia is now worth $3.2 trillion (£2.7 trillion), with its stock price rising almost seven times in the last two years. It is now the second largest company in the world.
US equity sentiment is near all-time highs, with fund managers holding record low levels of cash, while consumer expectations of higher stock prices are higher than they have been in decades.
So, what’s causing this mania for stocks?
Why are American stocks so expensive?
There’s a clear source for the high valuations of the US market: Tech.
“Investors have either got over-excited about AI, and the US stock market is in a bubble which could easily go pop,” said FTSE 100 trust Alliance Witan in its most recent investment commentary.
“Or, they have all underestimated the transformational impact of a new technology across the economy, in which case the share prices outside tech could catch up.”
Research from Absolute Strategy Research found that media mentions of ‘animal spirits’ had spiked to an all-time high in recent weeks, which could evident that the price of stocks is becoming un-tethered from their actual value.
But perhaps those valuations are fair.
Since only US stocks have been surging so much in value, it is worth noting that the US economy is in a much stronger shape than other countries.
US GDP over the last five years is 11.4 per cent, more than double any other country in the G7, while the country’s jobs market continues to hold up.
In addition, the AI boom seems to be solely focused on US companies, with the technological development of systems such as Chat GPT and Claude coming from the states.
“The greatest bubbles usually originate in connection with innovations, mostly technological or financial, and they initially affect a small group of stocks,” said Howard Marks, co-chair of Oaktree Capital Management.
“But sometimes they extend to whole markets, as the fervour for a bubble group spreads to everything.”
But while price to earnings ratios may seem staggering high, they are certainly lower than they have been in previous bubbles.
The Nifty-Fifty bubble in the 1960s saw PE ratios as high as 90 times, while the dotcom bubble saw PE ratios on the S&P 500 reach around 50.
“Many investors either aren’t able to get up to market weight on large cap tech or are nervous about stretched sentiment and valuations in the space,” said Bank of America analysts.
“But not owning enough US stocks or large-cap stocks or tech stocks has been a painful stance for many years, and we think it’s still a major risk in 2025.”