Does US market have value?

The question constantly being asked is “Is there any value left in the American stockmarket”?

If you look at the two largest stockmarkets in the world, the UK and US markets account for 60 per cent of the MSCI World index.

Yet, when you look a bit more closely at the underlying market statistics, there can be slightly different conclusions to be drawn.

For instance, the UK has a number of mega mergers in progress between large companies and it is likely the top 10 UK stocks will account for approximately 45 per cent of the FTSE.

The average price/earnings ratio for the UK market was 20.4 as at 31 December.

However, the average P/E ratio for the top six UK stocks was more than 40 compared to an average P/E ratio of the FTSE Small Cap index of just 14.

In the US the story is also interesting.

The average P/E ratio in the market is 30.2 and there was a price/book value ratio of 5.1 at 31 December.

The top 20 stocks, however, were trading at an average P/E ratio of nearly 42 and a P/BV ratio of 11.6.

The fundamental drivers of share markets are the prevailing interest rate environment and future earnings.

There is strong evidence to suggest that a high degree of correlation exists between the level of long-term interest rates and the valuations investors are prepared to pay for stocks.

As interest rates fall, P/E ratios increase. This is due to a lower discount rate being applied to future earnings in a low interest rate environment and investors generally being prepared to pay more for stocks.

The current interest rate environment in the US is a very benign one.

It seems this environment is expected to continue. In this scenario it is possible to make a reasonable case that the US share market is around fair value in overall terms.

In a recent article, Lend Lease investment management division CEO Bruce Coleman said an unexpected rise in interest rates would have a far greater impact on stocks now than at most other stages in the past 20 years.

“While all stocks would be adversely impacted by an unexpected rise in interest rates, the ‘megacap’ growth stocks may be hardest hit given they are trading at well above market multiples,” Mr Coleman said.

Where does this leave us?

It would appear Mr Coleman is suggesting the US stock market does have some value left in it.

However, he is mindful of the close correlation between interest rates and the P/E ratios.

Therefore, an unexpected surge in interest rates could have a fairly substantial impact on the valuations of stocks on Wall Street.

The ball would appear to be very firmly in Federal Reserve chairman Alan Greenspan’s court now.

Should he see fit to raise rates to quell any inflationary spiral, we could see a correction of some magnitude.

This could have its sympathetic reaction in Australia as we have said for some time.

Our saving grace in this regard is that we have a very low interest rate environment with little pressure in evidence to raise rates at present.

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