American shares trade at nearly twice the cost of UK shares. Sam Benstead asks if they still make good investments.
American companies have proved themselves serial winners relative to international peers, rewarding investors who dared to diversify overseas when it was less common to do so.
Over 20 years, the S&P 500 index has delivered 660% returns compared with 315% for the FTSE All Share, including the reinvestment of dividends. Looking back 35 years, to 1988, shows the US market tripling the returns of the UK market, delivering 4,642% compared with 1,607%.
The winning run for US shares increased in pace from 2012, when its technology giants began a decade of extraordinary growth as five companies came to dominate the online world: Apple, Microsoft, Google, Google and Amazon. Before then, the US and UK market were neck and neck, according to data from 1988.
This success has come at a price, however. Investors pay 21 times the index’s annual earnings for shares, known as the price-to-earnings (p/e) ratio, compared with 11.5 times for the FTSE All Share. The high price for shares is a reflection of investors’ expectation for better earnings growth.
So is it a wise move to pay nearly twice as much to own American shares? For Nathan Sweeney, chief investment officer for multi-asset at Marlborough Investment Management, the answer is an easy yes.
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He says that comparing US shares to UK shares is like comparing “Lamborghinis with oranges” because of their high-tech capabilities and greater profitability.
The latest advancements in artificial intelligence (AI) serve to justify the premium investors pay for US shares, as the main players globally are all American firms, including chip-designer Nvidia, Microsoft and Google (Alphabet), he argues.
Sweeney said: “Markets move up over time due to change in tech. There is now a new industrial revolution in technology thanks to AI.
“Goldman Sachs estimates that 60% of all jobs today could have as much as 40% of the workload done by AI, which will add to economic growth and lead to new jobs in new areas.
“We expect huge amount of advancement in tech and healthcare, and Covid created a proliferation of technology for this to reach people.”
This has of course been reflected in the shares of US tech firms, with the largest names (Google, Apple and Microsoft) up around 40% this year, and even bigger winners, such as Nvidia and Meta, up 200% and 120% respectively.
Sweeney is not worried that a bubble is forming, despite the huge share price moves this year.
He said: “The best firms are always going to hit higher highs, so I don’t worry about companies hitting all-time highs. Big tech names have rallied for good reasons this year, and the biggest firms can keep getting bigger still.”
Sweeney was therefore buying the dip in US shares last year. Funds he added to included Loomis Sayles US Equity Leaders and a Nasdaq-100 tracker fund, such as the Invesco EQQQ NASDAQ-100 ETF .
He adds: “Tech was down and out last year, and this was a great time to be buying.”
Does expensive signal future losses?
Research from fund manager Schroders shows that valuations continue to favour markets outside of the US, when looking at prices over the past 15 years.
Its data showed that, as of the end of May 2023, the US market was 10% more expensive than over the past 15 years, as based on earnings over the past 12 months, and 25% more expensive when looking at its dividend yield. On a price-to-book measure, which assesses share prices versus the value of a company’s assets, it is 44% more expensive than normal.
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In contrast, UK shares are 18% cheaper than over the past 15 years based on their earnings, and around neutral based on dividend yields.
Schroder Global Recovery, a fund that has a value investment style, has just 20% invested in US shares, compared with nearly 70% for the MSCI World benchmark.
The team behind the strategy said: “When you look at fundamental valuation metrics, it is clear the US market is piping hot. With a cyclically adjusted p/e ratio (CAPE) of 28 today, versus an average of 20x since Refinitiv data started in 1970, there’s no doubt we are well above normalised levels.
“Its current valuation has only been higher in 15% of all months since then. While we aren’t macro investors, we believe valuations mean revert over the long run and stock market history shows this to be true. Whether it is driven by human behaviour of fear and greed, or by the natural market cycle, history would suggest US valuations are unsustainable elevated.
“This is what we also observe from a bottom-up standpoint. While the US market accounts for nearly 70% of the global benchmark, we are only able to find a handful of companies that offer compelling returns given the associated risks.”
Another measure that American shares could be overvalued, is that companies operating in similar industries but are listed in the US are far more expensive than UK peers. Unilever and Diageo, for example, trade at p/e ratios of 15.5 and 21.5, compared with 25.2 and 40 for Procter & Gamble and Brown-Forman, the Jack Daniels owner.
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Pay up for quality
Terry Smith, manager of Fundsmith Equity, is happy to pay up for shares that are high quality. He currently has 65% invested in America and just 4.4% in the UK.
Writing in 2021, he said: “Our portfolio consists of companies that are fundamentally a lot better than the average of those in either index and are valued higher than the average S&P 500 company and much higher than the average FTSE 100 company.
“However, it is wise to bear in mind that despite the rather sloppy shorthand used by many commentators, highly rated does not equate to expensive any more than lowly rated equates to cheap.”
He said that paying up for quality businesses means you can beat the market. He calculated that in 1973 you could have paid a p/e of 281 for L'Oreal , 174 for Brown-Forman, 100 for PepsiCo, 44 for Procter & Gamble and 31 for Unilever and still made 7% a year in returns, compared with 6.2% for the MSCI World index.
“I am not suggesting we will pay those multiples, but it puts the sloppy shorthand of p/e's equating to expensive stocks into perspective,” he said.
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