By any number of valuation metrics, U.S. stocks look quite expensive. Canadian shares, by comparison, look like a bargain.
U.S. equities have rarely been as pricey as they are today, based on the cyclically adjusted price-to-earnings (CAPE) ratio, which takes a longer view of stock performance over the economic cycle. The U.S. ratio divides share prices for S&P 500 companies by their average earnings over the past 10 years, adjusted for inflation. It’s also known as the Shiller ratio, named for economist Robert Shiller, who popularized this valuation metric.
Investors often use the CAPE ratio to assess the potential long-term returns for a group of stocks. In this instance, the elevated CAPE ratio of 36.6 suggests there’s limited upside for U.S. shares in the coming years. In a recent forecast, Goldman Sachs strategists said the S&P 500 will post an average annual return of 3 per cent over the next 10 years, compared with 13-per-cent annual gains over the previous decade.
Meanwhile, the CAPE ratio for Canadian stocks was 24 in September – about equal to the previous 20-year average, according to figures from the research team at Barclays PLC.
During the 1980s and 1990s, valuations for Canadian and U.S. stocks tracked each other quite closely, based on the CAPE ratio. But more recently, a large gap has opened up, with American equities trading at pricier valuations.
Stocks have benefited this year from hype around artificial intelligence, solid economic growth and the lowering of interest rates, which is easing pressure on indebted households and businesses.
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