The US stock market is a dominant force in global equities, accounting for over 60% of total world market capitalization. However, current valuations suggest that US equities are overvalued compared to historical averages.
The Buffett indicator, which compares total market capitalization to gross domestic product (GDP), indicates that US equities are overvalued at 208%. The cyclically adjusted price-to-earnings (CAPE) ratio, developed by economist Robert Shiller, is also well above its long-term average at 31.12. Investors are advised to approach the US market with caution and reassess their investment strategies.
In contrast, European equities offer a more attractive valuation landscape. The CAPE ratio for the United Kingdom is 18.64, and Germany's is 20.07, both significantly lower than the US. European markets are trading at a considerable discount, with sector-adjusted price-to-earnings ratios approximately 18% below those in the US. This presents a potential opportunity for long-term investors seeking value.
Japan's equity market presents a mixed bag of valuation signals. The market cap to GDP ratio is 164.64%, indicating some level of overvaluation, but less extreme than the US. The Japanese CAPE ratio is 27.74, placing it between the levels seen in the US and Europe. Ongoing corporate governance reforms and efforts to improve shareholder returns have made Japanese equities more appealing to global investors.
Geographical diversification is a key strategy for investors given the varying valuation levels across different regions. European equities may offer better value for establishing new positions, while selective opportunities in Japanese markets could also be worth exploring. US investors may need to rebalance their portfolios and maintain discipline around position sizing. A balanced investment approach that incorporates multiple regions could optimize risk-adjusted returns.