RANDY FREDERICK: With equity markets very near record levels, the inevitable question of high valuations often comes up. Jeff Kleintop, Schwab’s chief global investment strategist, joins me for the June 29 Schwab Market Snapshot, to discuss how U.S. valuations stack up against other developed markets. Welcome back, Jeff.
JEFF KLEINTOP: Thanks for having me, Randy.
RANDY: So, Jeff, we’ve been hearing a lot lately how PE ratios on U.S. equities are really quite high at the moment. So how does the domestic market look relative to other markets around the world? And what’s the best way to compare them?
JEFF: Well, valuation comparisons can be tricky, even if you set aside the issue of what metric to actually use. I’d guess I’d say that trailing price-to-earnings ratio is probably the oldest and most well-known valuation measure—and that’s just looking, of course, as you know, at the price of a stock or an index, and dividing it by the trailing 12 months’ earnings.
If we compare the U.S. to Japan on that measure, Japan looks really cheap. Japan is trading at about 14 PE versus the U.S. at around 21, but that can be misleading. The U.S. stock market tends to perform like the tech sector—whereas Japan tends to perform a bit more like the financial sector—and tech is usually valued more highly than financials.
In fact, over the last 10 years, the U.S. has really tracked very closely the MSCI World tech sector. And that tech sector is valued at a PE of 22, not surprisingly, very close to the U.S. Japan tracking the financial sector, World Financials, valued at a PE of 15, very close to that 14 for Japan. So that’s not surprising, and we can see that in Europe, we can see that with lots of different countries. The key takeaway is that valuation comparisons across borders really tend to reflect how those markets tend to perform and shouldn’t be expected to be the same.
RANDY: So that’s really fascinating. If I understand you correctly, it sounds like you’re saying that a country tends to be valued very much like its dominant market sector. So, let’s say, we take those differences into account. Do you see any right at the moment that look relatively expensive or relatively affordable?
JEFF: Not right now, Randy. The typical valuation gap, for example, between tech and financials is usually around 7 PE points, and that’s exactly what we’re seeing between the U.S. and Japan. So the valuation differentials between sectors and across countries are currently not far from their 20-year averages. And that suggests that relative valuations, alone, don’t support a compelling reason to favor one country’s stock market over another. And, you know, given the fact that stock market valuations, overall, are above average, we’ve got to keep our eye on earnings here.
So even though between different countries they’re not very different, they’re in line with their averages, overall, they’ve above average. And that means earnings growth is critical to continue to lift the stock market and continue to support markets in the face of these higher valuations. That’s been the case so far this year. Hopefully, it will continue to be the case in the second half.
RANDY: That makes a lot of sense, Jeff. That’s really good to know. Unfortunately, that’s all the time we have for today. Thanks, so much.
Listen, if you want to read more from Jeff you can do that in the International Investing section of Schwab.com
, and you can follow Jeff on Twitter @JeffreyKleintop
. And, of course, you can always follow me on Twitter @RandyAFrederick
. We’ll be back again. Until next time, invest wisely. Own your tomorrow.