As I write this column, the S&P 500 Index in the United States is within a whisker of its all-time high. The greenback is on a tear against other key currencies and hype is building about Trump’s effect on US growth. According to reports, US business is ‘giddy’ with excitement about Trump pro-enterprise approach.
This bullishness is reflected in US shares trading on a whopping average forward Price Earnings (PE) multiple of 26 times earnings – or 6 points higher than Australian shares, according to AMP analysis. Remarkably, the forward earnings yield on US equities is less than the 10-year US bond yield.
Is this as good as it gets for US equities, at least in the short term?
This is a critical, complex question. I’ve been a long-term bull on US equities. In late November in this column, I highlighted the prospect of a rallying greenback after Trump’s victory in the US Presidential election.
I wrote in November: “… I expect the US dollar rally to continue over the next months. It might lose some steam in the next few weeks after the initial market reaction to Trump’s win, but his inauguration in late January and more updates on his intended policy reforms should stoke further risk appetite and a higher US dollar.”
The Betashares US dollar ETF (ASX: USD) was my preferred exposure to a rising US dollar against the Australian dollar, for traders and active investors. USD tracks the performance of the US dollar against the Australian dollar and is designed to rise 10% if the Greenback goes up 10% against our dollar, and vice versa. USD has starred lately.
Chart 1: BetaShares US dollar ETF
Source: Google Finance
Australian investors who hold US shares, particularly in funds unhedged for currency movements, have done exceptionally well, as shown below in the chart of the iShares S&P 500 AUD ETF (ASX: IVV).
Chart 2: iShares S&P 500 AUD ETF
Source: Google Finance
After gains like these, it’s easy to fall in love with an asset class. In US equities, the IVV ETF has an annualised return of about 16% over 10 years to end-December 2025.
That’s a terrific return from US equities – and shows why growth investors should always have exposure to US shares in the portfolio core.
But every investment has its price. The chart below shows the historic PE of US shares is the highest in at least two decades. The US market’s average historic PE over the past year (24.7 times) is about 6 points higher than its average over 10 years (18.8 times), according to World PE Ratio.
Chart 3: Historic PE of US equities
More concerning is index concentration in the US. The so-called ‘magnificent seven’ – Apple, Nvidia, Microsoft, Amazon, Meta, Tesla and Alphabet are worth about a third of the index by stock weighting.
Index concentration in the S&P 500 is now the highest in 60 years, meaning a bet on that index is increasingly a bet on a handful of tech stocks. Heaven help us if passive fund flows into US tech stocks turn and the crowd departs in a hurry.
Then there’s Trump. Judging by his past Presidency and current actions, he wants to see US shares move higher given his pro-business growth policies. For business, there’s a lot to like about some of his proposed policies (lower tax rates, cheaper energy). But other Trump-proposed policies, such as higher tariffs and deportation of illegal immigrants, would be inflationary through higher import costs and wages.
The market seems more focused on the growth potential of Trump’s policies than its inflationary impacts. That’s probably right, given the practical challenges of deporting millions of illegal immigrants and the likelihood that at least part of his tariff threat is ‘jawboning’ to get better trade deals for the US.
Still, there’s much policy uncertainty ahead for the US, plenty that can go wrong with implementation and the risks of fewer US rate cuts than expected if inflation edges higher again. Put another way, the Trump honeymoon now for US equity markets might not be as glowing in six months as reality sets in.
To be clear, I’m not suggesting investors dump their US equities exposure or that sharp falls are likely. Rather, that it’s prudent to take some profits off the table in US equities after such strong gains and rotate into undervalued assets in the global equities (developed markets) allocation within portfolios.
Long experience has taught me that too many investors extrapolate past gains too far into the future, get seduced by media and market hype, and are reluctant to take profits on winning ideas.
I expect US equities to deliver a positive total return this year, but that return will be more constrained than in previous years and come with increasing risk. That strengthens the argument lighten positions in US equities and take some profits.
Where to invest?
Investors who choose to trim their US equities exposure through could consider other developed markets, such as Europe and Japan, that significantly underperformed the US in 2025.
European equities look interesting. They were belted during the 2020 COVID-19 pandemic amid fears of a savage Europe recession.
The iShares Europe ETF (ASX: IEU), a barometer of approximately 350 European stocks across 16 countries, returned 11.2% over one year to end-December 2024. In contrast, the iShares Core S&P 500 ETF (ASX: IVV) returned 37% over one year.
IEU trades on an average PE ratio of 15.3 times, iShares data shows. IVV currently trades on an average PE of almost 30 times.
Whichever way investors cut it, European equities have massively underperformed US equities – a trend reflected in sharply lower average valuations for European equities compared to US shares.
US equities should trade at a substantial premium to European equities. The US economy is stronger, more dynamic and has better long-term growth prospects. But the average PE of US equities (as measured by IVV) is almost double that of European equities (based on IEU). That gap is excessive.
Just as US equities look increasingly overvalued, European equities look undervalued. A larger recovery in Europe will take time and won’t occur in a straight line. Expected setbacks along the way. But there’s more to like about valuations in Europe compared to those currently in the US.
Chart 4: iShares Europe AUD ETF
Source: Google Finance
Higher exposure to Japanese equities in 2025 is another option. I’ll have more to say about Japan in coming instalments of this column, but it looks interesting.
There was a burst of renewed interest in Japanese equities last year amid corporate governance reform, improving growth and higher foreign investment.
The iShares MSCI Japan AUD ETF returned 17.6% over one year to end-December 2024 – a strong performance by Japanese equities standards. Over five years, the annualised return is a modest 8.5%.
Like European equities, Japanese equities have badly underperformed US equities over short and long periods – and trade on about half the average multiple of US shares, based on a comparision of ETFs over US, Europe and Japanese equities.
Chart 4: iShares MSCI Japan ETF (ASX: IJP)
Source: Google Finance
Yes, my suggestion to lighten exposure to US equities could be too early this year, such is Trump euphoria. But when it comes to investing, I’d rather be a little early than too late when the herd turns.
The best time to sell assets is usually after strong rallies when hype peaks and market narratives can only see positives. When the ‘crowd’ gushes about an asset class, believing it can only head higher, it’s time to take a few profits.
Tony Featherstone is a former managing editor of BRW, Shares and Personal Investor magazines. The information in this article should not be considered personal advice. It has been prepared without considering your objectives, financial situation or needs. Before acting on information in this article consider its appropriateness and accuracy, regarding your objectives, financial situation and needs. Do further research of your own and/or seek personal financial advice from a licensed adviser before making any financial or investment decisions based on this article. All prices and analysis at 22 January 2025.