Are equity markets overvalued?
One of the most common questions we receive from both newly onboarded and existing clients is: Given the market’s strong performance last year, are we too late to invest? Are current valuations too high? An analysis of the factors driving the market’s strong performance reveals that a handful of heavyweight companies, spearheaded by Nvidia, have contributed significantly to global equity market growth. However, many companies with strong Quality characteristics remain undervalued and are yet to be fully recognized by the market. Additionally, the strong momentum factor in the U.S. market has played a pivotal role in propelling global stock indices higher. So, how expensive is the current equity market, and what is the probability of a market correction?
A key point to consider is the stark valuation disparity between U.S. and European markets—the largest divergence in the past two decades. European markets do not show signs of overheating, with valuation levels largely in line with historical averages. The U.S. market, on the other hand, does exhibit elevated valuation levels, and a potential correction might even be healthy for the market. However, two critical factors must be noted. First, there is a significant gap between the index-weighted P/E and the P/E median, indicating particularly high valuations among the index heavyweights, which saw significant rallies in 2024. Market average valuation, based on median PE calculation, still is below the level we saw in 2021. Second, with corporate earnings results set to be published soon—and considering that corporate America has been performing well—these elevated valuation levels are likely to be moderated as higher earnings press P/E ratios downward.
Index-weighted and median PE of MSCI USA and MSCI Europe
Source: Alphinox, Refinitiv
How poorly is the economy doing?
In the U.S., the economy remains robust despite notable weaknesses in the real estate sector, which continues to struggle under the pressure of high interest rates. Some challenges in the labor market, previously highlighted over the summer, persist. However, there are no significant signs of a downturn in business activity or consumer confidence. Corporate finances remain exceptionally strong, showing no indications of deterioration.
The situation in Europe presents a contrasting picture. Business activity has entered a critical zone and has been in decline for multiple periods. Despite this, the consumer sector appears surprisingly resilient, even after experiencing elevated inflation. The labor market in Europe remains solid and is performing better than its U.S. counterpart. Moreover, the housing and construction sectors are showing signs of revival as the European Central Bank (ECB) begins to implement rate cuts.
We remain cautiously optimistic about the economic outlook in the U.S., though we continue to monitor the labor market, which could face additional tension due to AI-driven automation. In Europe, however, the outlook is less promising, and the worst may not yet be over given the persistent challenges in business activity. These dynamics have been reflected in stock market performance, which often acts as a leading economic indicator.
Health status evaluation of Macroeconomy in USA and Europe
Source: Alphinox, Refinitiv
