This article was originally published at the Humble Dollar.
There's a lot of handwringing right now about U.S. stock market valuations. Prof. Robert Shiller’s cyclically adjusted price-earnings ratio, or CAPE, has rarely been more famous—or perhaps infamous. It’s currently perched near 39, meaning buyers of the S&P 500 are paying almost 39 times average inflation-adjusted corporate earnings for the past 10 years. That number might mean little to many without proper context. It was around five at the worst of the Great Depression, and under 10 in the late 1970s and early 1980s.
Jump ahead to the dot-com bubble and you’ll see that it peaked at 44 in December 1999. After that came an historic drop in share prices. With the current record-low interest rates and huge fiscal spending, we’re nearing those lofty late 1990s highs once again.
It’s likely some investors have thought about moving some money from U.S. stocks to foreign markets. After all, CAPE ratios are far lower in many other developed markets. There’s a twist, though: The U.S. market’s composition looks nothing like some of those foreign markets.
For example, the technology sector is 24% of the S&P 500 using Vanguard S&P 500 ETF (NYSE:VOO) as a proxy. Leap across the pond to Europe, and you’ll discover that just 8% of Vanguard FTSE Europe Index Fund ETF (NYSE:VGK) is in the tech sector. Fast-growing tech stocks command higher valuation multiples than cyclical and defensive sectors such as materials, financials, staples, energy and industrials. All of these sectors feature more prominently in Europe’s market makeup.
The quants out there can perform a sector-neutral valuation analysis to get a truer sense of each country’s stock market valuation. Indeed, looking beyond a standard valuation metric such as the CAPE ratio would be wise, especially if you’re considering making major changes to your stock portfolio’s geographical allocation.