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How Do U.S. Equity Market Valuations Compare to Other Developed Markets?

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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.
Important Disclosures
The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.
Please note that this content was created as of the specific date indicated and reflects the author’s views as of that date. It will be kept solely for historical purposes, and the author’s opinions may change, without notice, in reaction to shifting economic, market, business, and other conditions.
Data contained herein from third party providers is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed. Supporting documentation for any claims or statistical information is available upon request.
Past performance is no guarantee of future results and the opinions presented cannot be viewed as an indicator of future performance.
Investing involves risk including loss of principal. International investments involve additional risks, which include differences in financial accounting standards, currency fluctuations, geopolitical risk, foreign taxes and regulations, and the potential for illiquid markets. Investing in emerging markets may accentuate this risk.
Diversification strategies do not ensure a profit and do not protect against losses in declining markets.
Indexes are unmanaged, do not incur management fees, costs and expenses, and cannot be invested in directly.
Definitions
P/E ratio (price/earnings ratio) is a measurement that represents the relationship between the price of a company’s stock and its earnings for the past year. To get a company’s P/E ratio, divide its current price by its earnings per share (EPS) for the past year.
The MSCI USA Index is designed to measure the performance of the large- and mid-cap segments of the U.S. market. With 633 constituents, the index covers approximately 85% of the free float-adjusted market capitalization in the U.S.
The MSCI Japan Index is designed to measure the performance of the large- and mid-cap segments of the Japanese markets. With 318 constituents, the index covers approximately 85% of the free float-adjusted market capitalization in Japan.
The MSCI World Information Technology Index is designed to capture the large and mid-cap segments across 23 Developed Markets countries. All securities in the index are classified in the Information Technology sector as per the Global Industry Classification Standard (GICS®).
The MSCI World Financials Index is designed to capture the large and mid-cap segments across 23 Developed Markets countries. All securities in the index are classified in the Financials sector as per the Global Industry Classification Standard (GICS®).
The MSCI Europe Index captures large- and mid-cap representation across 15 developed-market countries in Europe. With 443 constituents, the index covers approximately 85% of the free float-adjusted market capitalization across the European developed-markets equity universe.

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