It’s been a fantastic run for the US sharemarket.
The S&P 500 index is up 18 per cent in the past 12 months, and 83 per cent over three years.
Even Federal Reserve Chair Jerome Powell has commented on this, noting that “equity prices are fairly highly valued” during a recent speech.
To be fair, he was responding to a question, rather than feeling the need to proactively offer an opinion.
For the record, I don’t believe US stocks are in a bubble.
I do, however, agree they’re looking pricey.
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That means investors need to tread carefully, and think a little harder about how they spread their exposures.
Valuations for the US market are at highest levels we’ve seen in some time.
The widely used price/earnings (PE) ratio is 22.8, well above the average since 1990 of 16.6 and the 18.7 average of the last decade.
The only time it’s been higher was in the late 1990s, in the days that preceded the dotcom boom and bust.
Things are eerily similar today, with the market strength being driven largely by companies associated with AI trends.
The big three – Nvidia, Microsoft and Apple – together make up more than one-fifth of the S&P 500.
Last month Deutsche Bank produced a fascinating chart to really put this into perspective.
It showed how Nvidia’s market value had surpassed the total value of every country in the world’s entire listed stock exchange apart from the US, China, Japan and India.
Let that sink in. One company is more valuable than all the listed companies in Canada, or the UK, or Germany.
The US market is more concentrated than we’ve seen in decades and while that’s a risk, it also makes those PE comparisons less useful.
The tech behemoths of 2025 have increasingly dominant positions, high margins and very profitable business models.
Can you really compare them with the biggest companies of 20 years ago?
In 2005 Exxon Mobil was the largest stock on the market, while Citigroup, General Electric and Walmart were in the top five.
The earnings power of this class of 2025 is hugely exciting, if you’re a believer in the productivity growth potential of AI.
It can’t be overstated how important this is, because it’s earnings growth that ultimately drives share prices (at least in the longer term).
Earnings for the US tech sector grew 23 per cent in the June quarter, relative to a year ago.
The communication services sector (where the likes of Meta and Alphabet reside) saw an even larger gain of 46 per cent.
Looking ahead to 2026, analysts are projecting earnings growth for the S&P 500 index of almost 14 per cent, double the long-term average of about seven per cent.
The so-called Magnificent 7 are expected to contribute as much as two-thirds of this.
Even if the earnings tailwinds can justify the higher valuations and keep pushing the US market higher, there’s a strong case for diversification right now.
Other sharemarkets look more reasonable when we compare current valuations to long-term averages.
The UK and Europe are trading in line with history, emerging market shares are only slightly higher, while Japan looks cheaper.
Even within the US itself, there are sectors which have lagged and look better value.
Healthcare, energy and real estate are trading in line with their longer-term average PE, while utilities and consumer staples are only at a modest premium.
Each of those regions and sectors will be facing its own unique backdrop, and valuation alone isn’t an indicator of where prices will go in the next year or two.
However, for investors feeling uneasy about the ongoing strength of American equities, there are plenty of ways to hedge your bets.
Valuations across the US sharemarket are indeed high, but it could keep performing well if the economy remains resilient, the Fed keeps reducing interest rates and the tech sector keeps delivering solid earnings.
At the same time, it would be unwise to ignore the risk things are a little overdone.
The astute investor is probably ensuring they have an exposure to markets outside the US, while maintaining a healthy foothold in the world’s biggest economy.
Market Insights enewsletter
Keep up to date with our fortnightly Market Insights enewsletter. Our research team provide timely and regular commentary and analysis on market developments, understanding investment jargon, and the impact of current events.
Mark Lister
Investment Director
Market Insights enewsletter
Keep up to date with our fortnightly Market Insights enewsletter. Our research team provide timely and regular commentary and analysis on market developments, understanding investment jargon, and the impact of current events.