S&P 500 at 2000: Have US shares become too expensive?

The main US stock market - the S&P 500 broke through 2000 points last week - but are US shares expensive or cheap?

Wall Street, American Flag, New York City, New York, USA, North America, America
The US stock market has been one of the best performers since the financial crisis Credit: Photo: Alamy

Share prices in America hit a record high last week. The main US index, the S&P 500, broke through the 2000-point barrier for the first time. It has left investors with a simple question: is this a sign of a bull run or are American shares ripe for a fall?

Naturally, many are looking down rather than up. One analyst said shares could fall by 60pc in a “scary” crash.

Why have shares risen?

The US stock market fared worse than most in the financial crisis. Since then it has recovered strongly, making it one of the fastest-growing markets in the world. A saver who put £10,000 in a fund that tracked the S &  P 500 in November 2009 would now have £19,400 – a 94pc return.

Economic growth in America has been better than expected, giving investors confidence. Growth picked up steam between April and June, with the economy expanding at an annual rate of 4pc. This reversed a 2.1pc decline registered in the previous three months.

America’s energy revolution, brought about by a boom in fracking for shale gas, and its improving housing market have also sent share prices higher.

Too late to buy?

Just a day after the S&P 500 closed above 2000 for the first time, Abigail Doolittle, founder of Peak Theories Research, told CNBC that the Federal Reserve’s reluctance to raise interest rates lows could lay the grounds for a crash.

Investors should analyse the data to make up their own minds. Experts use three measures of “value” to assess whether shares are worth buying.

The most widely used is the price to earnings ratio, known as “p/e”. This measures a company’s stock market value against annual profits. The ratio can be compared with a long-term average to show whether an entire stock market is attractive.

American shares are trading on a p/e of 20. The historical average is 16, so it looks expensive. However, the record high for American shares was set in June 1999 during the tech boom, when the p/e ratio was 31.

The two other popular measures of value suggest shares are overpriced. It sounds complicated, but the “cyclically adjusted price to earnings ratio”, or Cape, is very useful. It uses the same formula as the p/e ratio but instead extends the calculation over 10 years. This gives American shares a score of 25, which is only marginally ahead of a long-term average of 24.

Finally, there is the price to book ratio. This looks at a stock market’s value compared with the underlying assets held by all the companies listed. The value of buildings, machinery and intangible assets is all factored in. The ratio scores American shares at 2.8, higher than its 2.5 average.

Laith Khalaf of Hargreaves Lansdown, the broker, said investors were right to be wary of piling into American shares given these ratings. A more prudent approach would be to drip feed through a regular savings plan, he said. Investing on a monthly basis throughout the year discourages investors from second-guessing rises and falls. This limits the risk of losing money.

“Many investors probably feel they have been stung by two market highs in recent times, in 1999 and 2007, and are naturally wary of investing at a high point in the market. Valuations are nowhere near the highs reached in the past, but they are expensive compared to history,” said Mr Khalaf.

How to invest safely

Fund managers find it tough to beat the S & P 500. It is difficult to unearth hidden gems because information is so widely available about all companies listed.

In most cases, investors are better off using a tracker fund that aims to replicate the growth of the S&P 500. The cheapest are Vanguard S&P 500 Ucits ETF and the Fidelity Index US Fund, which cost 0.07pc and 0.08pc respectively.

Andy Parsons of The Share Centre said the best actively managed funds were Legg Mason ClearBridge US, Aggressive Growth and JP Morgan US Equity Income.

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