In the USA, the S&P 500 index closed at an all-time high of 3,389.78 points on Tuesday. The NASDAQ hit a record too, and the Dow Jones Industrial Average is within a few percent of one. By contrast, the FTSE 100 is still down close to 20% this year. And at 6,087 points, it’s way below 2018’s all-time high of 7,903.5.
If stock markets genuinely reflected the real long-term earnings of their constituent companies, then we might expect new records to be a regular occurrence. But the real world is volatile, and I find this latest US stock market boom scary. It makes me feel twitchy about our dear Footsie too.
Valuation
The S&P 500 is currently on a P/E multiple of a little over 29. That is, the price of an S&P share on average is 29 times the value of its earnings. The long-term average for that index comes in at around 15 to 16 — an average that’s similar to the FTSE 100.
We’re not looking at forecast earnings here, which we’d expect to raise an index’s apparent valuation in the short term. No, this current S&P 500 valuation is a trailing one, based on reported earnings. So it’s mostly unaffected by the pandemic slowdown yet.
Earnings forecasts are really not very reliable right now. But America is in its worst economic downturn since the Great Depression (as is much of the world). And as more and more weak earnings reports come in, that P/E is going to rise further and further. Unless, of course, there’s a correction in share prices.
Dividends
To look at it another way, we can turn things round and look at dividend yields. That is, the ratio of the average dividend to the average share price. At the moment, the S&P 500 is on a dividend yield of 1.8%. Again, that’s a trailing figure based on reported dividends. And if dividends are cut during the recession, that yield will drop too.
But what does the FTSE 100 look like in similar valuation terms? Well, the Footsie is on a trailing P/E of approximately 16 at the moment. So S&P stocks are valued a full 80% higher than FTSE 100 stocks. And looking at dividends, the FTSE 100 yield stands at around 3.5%. That’s down from last year, even after the index’s fall, but it’s still around twice the S&P 500’s yield. What does this all say to me about the prospects for the FTSE 100?
FTSE 100 set for a fall?
Firstly, I think US stocks are overvalued. They’re high by historic standards, but the Covid-19 havoc makes today’s valuations look like madness to me. I really can see a correction coming. And when the US stock market falls, the rest of the world tends to follow suit. That leads me to rate the probability of a further UK stock market downturn as significant.
But it looks like we have a far wider safety margin with the FTSE 100, as P/E multiples are not going crazy and dividend yields are holding up better than we might have feared. What should UK investors do? I think the secret to successful investing has not changed. If we find shares in top FTSE 100 companies on attractive values, especially ones with a defensive edge, we should carry on as usual and buy for the long term.