This is an audio transcript of the Unhedged podcast episode: ‘Is America overpriced?’
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Ethan Wu
2023 was a great year for US stocks and in truth, the last decade’s been pretty good for US stocks overall. The question on a lot of investors’ minds is, can the US keep on winning? This is Unhedged, the markets and finance show from the Financial Times and Pushkin. I’m reporter Ethan Wu here in the New York studio, joined by red-blooded American patriot Robert Armstrong.
Robert Armstrong
I am draped in the flag here, buddy. Feeling good.
Ethan Wu
Robert, where do you park your eagle when you drive it into work every day?
Robert Armstrong
I have an aviary. Is that what you call the thing you put a bird in? I have an enormous aviary for my giant mastodon American bald eagle that is on top of my apartment.
Ethan Wu
We’re gonna be hearing from the ornithologists of the Unhedged audience about how we completely messed that up. (Robert laughs) But anyway, we’re not talking about birds today. We’re talking about US stocks, which are also flying high. And I think we wanna consider this on three dimensions, right? One is the valuation of US stocks — how expensive are they? The other is what do the fundamentals look like, right? If you’re paying up, what are you paying for? And thirdly, what does the rest of the world look like? What do the alternatives to US stocks look like?
Robert Armstrong
Very good. Let’s start with pricing.
Ethan Wu
Yeah, Let’s start with pricing. So I mean, expensive. There’s a premium. You pay more for US stocks.
Robert Armstrong
It’s not just a premium, Ethan. It is a historically large premium. So the S&P 500, the index of large-capitalisation US stocks, which we focus on at Unhedged, it’s at about 23 times earnings. Most markets in the rest of the world — let’s talk about Europe or let’s talk about emerging markets, Japan, are at like 15 times earnings. Some of them are at less. Let’s unpack what that price/earnings ratio means. That means to buy a current dollar of profit in the United States, you pay $23. The rest of the world, you’re paying $15. It’s a huge difference. And that difference has just gone from very little to 50 per cent over the last 10 years. The wedge is just getting bigger and bigger.
Ethan Wu
Yeah. You pay roughly 50 per cent premium to buy US stocks over the rest of the world. Like you said, that’s expensive. It’s historically expensive. The question, of course, is what do you get for that price? You know, if you can buy something that’s twice as good for 50 per cent more, it’s a pretty good deal. So what are you getting for that $1.50 on US stocks?
Robert Armstrong
Well, you are getting the most awesome country in the history of the world. Let me explain. Demographics — much better in America than in the rest of the developed world, meaning, we’re gonna have a larger working-age population relative to the total population for longer than the rest of the world. We won’t face a demographic crisis to the degree that other developed countries will.
We have a huge internal market, which means our companies can sell a lot of product to people within America. And that means unlike countries like the UK, which are basically completely caught in the flow of global trade, there’s an island of stability effect in the United States.
And of course, we have a great corporate culture. We have strong rule of law, we have great companies. We have a huge lead in particular in technology. We spend way more in research and development.
And there’s a lot of doomerism around about America. You know, people on the right, people on the left, everybody like say, boo hoo, America, this, America that. Well, we make more oil and gas in America than Saudi Arabia now. You know, greenhouse gases or whatever. But just as an economic matter, you know, we’re the biggest oil and gas exporter in the world, we are the biggest exporter of food in the world, we’re the biggest farming country in the world. In a lot of ways, America is just extraordinary.
Ethan Wu
Yeah. And you see that show up in stock returns. In the past 10 years, which has coincided with an incredible boom in technological development in the shale revolution, which completely changed the US global energy position, US stocks overall returned 12 per cent. Now, that number is a little bit distorted, you could argue, because there’s, as we talk about almost every episode of Unhedged, there are the Mag Seven tech stocks. Those kind of distort the market because they take up so much of the headline indices. So another way to look at it is by looking at the S&P 500 Equal Weight, which treats all 503 companies in the S&P 500 as equal instead of overweighting Apple and Microsoft or whatever.
Robert Armstrong
The biggest companies.
Ethan Wu
Yeah. On that basis, S&P 500 Equal Weight, in the past decade, returns have been 10 per cent, which is pretty respectable.
Robert Armstrong
Killing the rest of the world.
Ethan Wu
Yeah. And that . . .
Robert Armstrong
Even on that basis.
Ethan Wu
Even on that basis, equal weight, that beats Japan at 6 per cent, (inaudible) the UK at 2 per cent, emerging markets at 3 per cent and Europe at 5 per cent. I mean . . .
Robert Armstrong
That’s a whippin’.
Ethan Wu
You doubled the rest of the world. That’s amazing.
Robert Armstrong
Amazing. I mean, obviously, if you’re gonna anticipate that kind of outperformance, you’re very happy to pay more. The problem is, that is not consistent with some very basic truths about markets. Some version of the efficient markets hypothesis is roughly correct. In other words, when a company or a market or a country or an asset or whatever has particular advantages, there’s a lot of smart people out there in the world trying to take advantage of that and to buy that asset, so prices will come to reflect those advantages. So if you think, if you’re sitting here thinking America has outperformed massively for 10 years, I’m gonna overweight America or stick with America. What you’re saying is that view of markets, the efficient view of markets, there’s something wrong with it in the case of the United States.
Ethan Wu
That there’s good news priced in and there’s going to be even more good news into perpetuity.
Robert Armstrong
Yeah, that there’s some . . . Or it’s not fully priced in yet, right? There’s something wrong with the pricing mechanism, what you say. And by the way, this is not a crazy thing to think. You know, a lot of my thinking about this started with a report from Goldman Sachs Wealth Management and a big report this week, basically making the case for despite United States outperformance, staying with your allocation to the United States, not rebalancing away because the American market is just so extraordinary relative to the rest of the world.
Ethan Wu
And, you know, one experience you’ve talked about, Rob, that sort of informs your view here is what happened in the rest of the world a couple of decades ago.
Robert Armstrong
Yes.
Ethan Wu
Between 2004 and 2014, emerging markets put up an 11 per cent return performance. That’s exceptional.
Robert Armstrong
Ten years ago to the day, the argument was emerging markets. These are markets that have emerging middle classes. They will have a higher secular growth rate than developed markets like the United States. Stay overweight emerging markets. They will be better. I heard those arguments. I bought an emerging market ETF that I still own and it has acted like crap ever since. So it just adds to my confusion at this point. And this is frankly, this is one of those situations where I have one thing going on intellectually and another thing going on emotionally. So emotionally, I look at my portfolio and America has been awesome for 10 years. I regret all this global diversification I have in my portfolio. It’s underperformed. I should have been 100 per cent S&P 500 and I just wanna stick with it. That’s what my stomach tells me. At the same time, I’m a huge believer in mean reversion. That, you know, if a single market outperforms it’s gonna work its way back to mean performance.
Ethan Wu
Yeah. That’s right. Now, we know these long-term studies of stock market returns tend to find 6 to 7 per cent inflation-adjusted return.
Robert Armstrong
High sixes, low sevens.
Ethan Wu
Yeah. That’s like the long run past century and a half equilibrium for stock markets.
Robert Armstrong
Let me give you some numbers, Ethan. So this is since, this is the postwar, this is since 1950 to 2023. These numbers come from the great Credit Suisse Global Investment Returns Yearbook. Wonderful. (Laughter) I don’t know if it’s called the UBS Returns Yearbook now, I don’t know. But it’s a great thing they put out every year.
1950 annual average compound returns. World equity markets 6.7 per cent, UK 6.9, Japan 7.3, Germany 7.8, Brazil 6.2, USA 6.9. You see the pattern there, which is over any sufficiently long period, equity returns in any market close in on that high sixes, low sevens. You know, Germany obviously has had an awesome 70 years. Maybe that’s exceptional because it was a pile of rubble 70 years ago. But the point is very clear. So we should expect, right, that over time the US’s extraordinary performance will revert to the mean. Intellectually, that’s an argument I buy. Spiritually, I’m having trouble getting with it.
Ethan Wu
So we’ve laid out the issue here. We’ve laid out kind of why people differ on it. There’s different dimensions. You can cut it different ways. Let’s talk about how we feel. You know, what do we think if we had to put our money down? I mean, you do have money down on this. You have a high US allocation.
Robert Armstrong
Yeah. I have a high allocation to the United States because my United States exchange traded funds have outperformed everything else I got. So I have a real question to face now, which is do I rebalance away from the United States? And I’m having trouble pulling the trigger, man.
Ethan Wu
I would argue you should. And here’s why. Emerging markets have gotten a lot better on a fundamental basis over the past 10 years. You’ve seen kind of a slow increase in economic management. I mean, look at basket cases like Turkey that are kind of slowly getting their stuff together.
Robert Armstrong
You could make an argument right now. And a lot of people did, that actually, emerging markets central banks as a rule — there is exceptions, Turkey, whatever — but emerging markets central banks actually handled this last inflationary incident better than the developed world central banks.
Ethan Wu
Absolutely. Brazil, Mexico, South Africa, they anticipated the Federal Reserve interest rate increases and they acted accordingly, raising rates before the Fed did.
Robert Armstrong
They did not screw around.
Ethan Wu
And the reason for that is these emerging market central banks and just, you know, finance ministers and treasury managers in general in these economies have 30 years of experience with currency crises and imported problems from abroad. They don’t have the more closed economy the US has. They’re more susceptible to global shocks. They’ve gotten better at being able to anticipate and prevent those. And that’s a fundamental improvement in the economy that should ripple into the stock market.
Robert Armstrong
Here is another argument for those emerging markets that look cheap right now, which is there’s a lot of bad news out there because of our global experience with two what used to be kind of market darling emerging markets, namely China and Russia, which have moved away from free market economics and towards authoritarianism. People are spooked about emerging markets, you know, and ever since the Rothschilds, it’s been a cliché that one should buy to the sound of cannons. Well there’s a few cannons. The emerging world.
Ethan Wu
Yeah. So the fundamentals are better for EMs now that there are some wars going on. And the valuations are perfectly reasonable to cheap. That to me seems like a set-up for 10 years of EM outperformance. And maybe conversely, some gains-taking on the US side of your portfolio that it can move into this portion.
Robert Armstrong
Ethan, I hear you intellectually, emotionally at a time . . . You know, I know I just gave the buy to the sound of cannons argument, but let me flip it around. At a moment where the world looks uncertain, I feel like all valuations and all financial rationality aside, we might be entering a period where there’s an extremely high premium for safety in the world, and that for a little while longer, money might wanna head for the United States, which is a rule of law country with a deep, liquid and open financial market and, you know, great companies to invest in. So I agree with you, your intellectual argument for overweighting. Intellectually, it’s gonna be really hard for me to sell United States stocks this year.
Ethan Wu
All right. We have put our chips down. We’ll be back in 10 years to talk about how we both did.
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Listeners, tell us how you’re feeling about US stocks. Overvalued? Fair? Undervalued? Email me, ethan.wu@ft.com. All right, Rob, we’ll be back in a moment with Long/Short.
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Welcome back. This is Long/Short, that part of the show where we go long a thing we love, short a thing we hate. Rob, I am short polyamory. (Robert laughs) Which I have no problem with, but there’s a great big magazine package in New York Magazine this week about how trendy polyamory is and a guide for curious couples. And it’s just I, you know, reading about it in The New Yorker, all the trendy magazines want to talk about how in polyamory is, which I think makes it not in.
Robert Armstrong
Yeah. It’s going the other way. So you’re selling polyamory.
Ethan Wu
I’m selling polyamory. The stock is going down.
Robert Armstrong
Cool, man. I am long — this is not as sexy long. In fact, it’s the opposite of that. However, I’m kind of long the insurance industry, specifically kind of property casualty insurance industry. Now, everybody hates on this industry a little bit because, you know, the doomers, again.
Ethan Wu
Climate change.
Robert Armstrong
Climate change and stuff. But after five years of too much capital coming into the space and a lot of big disasters, I’ve been talking to insurers lately. The pricing is good, the contracts are written harder, and like, this is an industry that is adjusted to a new world and is rational, and the stocks are cheap. And, you know, we’re gonna keep having hurricanes and earthquakes and everything else, terrorism, cyber attacks. But I think the cycle is turning in the insurance industry’s favour. I’m into it. I’ll be watching it closely, in any case.
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Ethan Wu
I’ve got a Miami-based insurance company stock to sell you, Rob.
Robert Armstrong
(Laughter) Oh, Miami. That’s another question.
Ethan Wu
All right, Rob, thanks for being here. We’ll have you back soon. Listeners, we’re back in your feed on Tuesday with another episode of Unhedged. Catch you then.
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Unhedged is produced by Jake Harper and edited by Bryant Urstadt. Our executive producer is Jacob Goldstein. We had additional help from Topher Forhecz. Cheryl Brumley is the FT’s global head of audio. Special thanks to Laura Clarke, Alastair Mackie, Gretta Cohn and Natalie Sadler. FT Premium subscribers can get the Unhedged newsletter for free. A 30-day free trial is available to everyone else. Just go to ft.com/unhedgedoffer. I’m Ethan Wu. Thanks for listening.
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