about 1 year ago • 2 mins
When comparing the attractiveness of stocks in different regions, you want to look at valuations from two angles: from the way a region’s valuation stacks up against other regions, and from how it stacks up against its own history. If the region ranks high on both measures, it’s most likely overvalued. If it ranks low on both counts, it’s most likely undervalued.
Take US stocks, for instance: they’ve not only got the most expensive 12-month forward price-to-earnings (P/E) ratio right now, but their current multiple is also near the top of their 20-year range. US stocks then are probably expensive. On the other end of the spectrum, there are UK stocks: their P/E ratio is the lowest in the universe, and they’re extremely cheap relative to their own history. So UK stocks are likely cheap.
Of course, different regions have different sector exposures, which also vary over time. That means you’re not exactly comparing apples to apples, and that can bias the results. For example, the tech sector grew significantly in the US over the past 20 years, and now represents a much higher share of stock indexes than it does in other regions. Tech stocks have a higher growth profile, and so they deserve a higher multiple, so it’s easy to see why US stocks have that elevated multiple relative both to other countries and their own history. That being said, the gap is so wide that differences in sector compositions can’t explain it all (and sector-adjusted price-to-earnings ratios between Europe and US, for one, support that view).
Valuations are a major driver of long-term returns. So, if you’ve got a long-term horizon, you might want to consider rotating some of your US stock exposure into regions like the UK, Europe, and Japan, which all have a nice, higher valuation cushion.
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