After a multi-year bull run, U.S. equities are fairly valued if not overpriced and are beginning to slow. On the other hand, international stocks and exchange traded funds may offer better opportunities going forward.
On the recent webcast, Sourcing Growth in a Growth-Starved World, Ted Lucas, Managing Partner and Investment Committee Chairman for Lattice Strategies, explained that U.S. stocks show less favorable valuations with headwinds ahead.
“Our research shows that the fertile conditions of past bull markets – low starting valuations, poor fundamentals and double-digit starting yields – have reversed,” Lucas said.
For instance, back in 1982, the S&P 500 index showed a price-to-earnings multiple of 7.7 times, whereas the benchmark was trading at a P/E of 18.5 times in October 2015. Meanwhile, the cyclically adjusted P/E multiple, or CAPE ratio, shows an even wider divergence, with a 7.4 times reading in 1982, compared to 24.6 times two months ago.
Moreover, historical data also shows that P/E levels typically rise after interest rates fall, and vice versa. With the Federal Reserve largely expected to hike interest rates ahead, we may see lower growth.
“Record-low interest rates and above-average P/E levels pose a very real challenge to long-term returns,” Lucas said.
Alternatively, Lucas pointed to developed markets outside the U.S. and emerging markets that are more attractively priced. For example, developed markets ex-U.S. show a 14 CAPE reading or slightly above the historical lows of 11, and the emerging markets have a 11 CAPE reading, which is their historical low level. In contrast, U.S. stock CAPE readings are in the mid-level of their historical range.
“There are more fertile opportunities for long-term growth in developed ex-U.S. and emerging markets equities,” Lucas added.