Concerns about potentially unsustainable high valuations in US equities have led Scott Gallagher, director at Rowley Turton, to maintain an underweight allocation to the market.
Gallagher said: “Generally, I avoid taking too aggressive an asset allocation stance for clients, as the risks of being wrong can often outweigh the benefits of being right.
“I prefer instead to give the fund managers within our multi-asset funds the flexibility to adjust positioning as they see fit.
“That said, our portfolios tend to remain underweight the US, given ongoing concerns about the higher valuations of US equities relative to the rest of the world, and the risk that the US market could one day experience a 1980s/90s-style Japan scenario — where extreme valuations were followed by a sharp fall and a prolonged period of market stagnation.”
In recent weeks, the top end of the equity market has once again driven global and US equity performance.
But there are concerns that US equities is in a bubble.
As explained by Wolf von Rotberg, equity strategist at J Safra Sarasin Sustainable Asset Management, the Nasdaq – led by the Magnificent Seven – has surged 50 per cent from its early April lows, boosting its year-to-date gains to 19 per cent.
This rally has been fuelled not only by the US administration’s shift on tariffs but also by surging capital expenditure (capex) announcements in recent weeks and a weaker US dollar in the first half of the year.
Today’s market is different: the Magnificent Seven, all Nasdaq constituents, account for over 20 per cent of S&P 500 earnings
But one question circulating, according to Rotberg, is whether the US equity market is edging into bubble territory.
Von Rotberg added: “Since the term ‘bubble’ is not clearly defined, we compare the current market behaviour to the dot-com exuberance of the late 1990s and early 2000s.
“There are notable parallels but also key differences, leaving the market vulnerable yet less precarious than it was then.
“To provide a comprehensive picture, it is useful to compare today’s market with that period across various valuation metrics.
“First, the Nasdaq Composite’s price to earnings (PE) ratio remains far below the record levels of the dot-com era.
“In 2000, the PE soared above 70-times, while today it is roughly half that level.”
According to Von Rotberg, this suggested the market was not overly stretched in terms of valuations.
However, during the dot-com bubble, the Nasdaq included many young, unprofitable tech firms, which naturally inflated PE ratios due to low earnings.
“Today’s market is different: the Magnificent Seven, all Nasdaq constituents, account for over 20 per cent of S&P 500 earnings.
“Since the early 2000s, Nasdaq earnings have risen approximately 30-times, while S&P 500 earnings have increased by about five-times.
“Thus, drawing parallels to the early 2000s is more appropriate using the S&P 500, which was a mature index and remains so today.”
This, Von Rotberg said, showed direct comparisons with the early 2000s overstated the bubble risk for the Nasdaq, because earnings strength now provided more justification for higher valuations, whereas the S&P 500, the main benchmark of US equities, told a more worrying story.
“Valuations paint a more concerning picture. The S&P 500’s PE ratio, based on 12-month forward earnings, stands at 23-times – matching its 2021 cycle high and approaching the 25-times peak seen during the dot-com boom.
“This suggests current valuations may be in dangerous territory, potentially ripe for correction.”
