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Stocktake: Just how expensive are US stocks?

Take low interest rates into account and the valuations start to look more reasonable

Nobel economist Robert Shiller’s excess Cape yield, which considers both equity valuations and interest rates, suggests US stocks are,at worst, only slightly expensive. Photograph: Taylor Hill/Getty Images
Nobel economist Robert Shiller’s excess Cape yield, which considers both equity valuations and interest rates, suggests US stocks are,at worst, only slightly expensive. Photograph: Taylor Hill/Getty Images
Proinsias O'Mahony's picture
Proinsias O'Mahony
Tue Jan 25 2022 - 00:00

Investors’ ongoing preoccupation with interest rates is mirrored in the debate around US equity valuations.

US stocks look expensive, but bulls argue this is justified by low rates. For example, Nobel economist Robert Shiller’s cyclically-adjusted price-earnings (Cape) ratio suggests stocks are very expensive. However, Shiller’s excess Cape yield, which considers both equity valuations and interest rates, suggests stocks are, at worst, only slightly expensive.

Adjusting for rates certainly changes things, says Liberum strategist Joachim Klement. His calculations suggest that compared to the last 15 years, US valuations are "on the border between fair and expensive" if you adjust for low rates.

So all clear for US stocks? Well, no. The same methodology gives an adjusted price-earnings ratio of 13.8 for Europe and 11 for the UK, compared to 24.7 for the S&P 500.

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In other words, says Klement, if adjusting for low rates really is the best way to predict future returns, then investors should be stocking up on UK and European stocks right now, not US stocks.