By looking under the hood, a key driver of this expansion has been elevated profit margins, which have hovered between 8.5 per cent to 9.5 per cent for the best part of a decade. Therefore, one should be careful to expect these margins to be sustained, especially given they are meaningfully higher than the longer term average of about 7.5 per cent.
Furthermore, it has also become clear that the price growth has far exceeded any reasonable estimate of this fundamental growth. For example, the cyclically adjusted price/earnings ratio (Cape), pioneered by Nobel Prize winner Robert Shiller, shows the relationship between prices and longer term earnings. On this metric, valuation pressures are now at the second highest point since the great depression of 1929 and second only to the tech wreck of 2000.
Bringing these two variables together – fundamentals and valuations – the valuation-implied return could be closer to 0.1 per cent in real terms the next 10 years – and 2.9 per cent over 20 years – rather than the 5.7 per cent we have become accustomed to from US equities when valuations are not stretched.
Therefore, I encourage looking through the recent positivity and Mr Trump’s rhetoric – including any speculation over whether he will be impeached – and instead analyse reward for risk. In doing so, one is likely to find that better opportunities reside outside the US.
One should bear in mind Sir John Templeton’s wisdom when he said: “Bull markets are born on pessimism, grown on scepticism, mature on optimism and die on euphoria.”
This is a simple yet apt way of thinking about US equities at the current time.
Dan Kemp is chief investment officer, Emea, of Morningstar Investment Management Europe
