Stocktake: Reasons not to be cheerful about stocks

One strategist who clearly doesn't think stocks should be at all-time highs right now is GMO's James Montier, as evidenced by the title of his latest white paper, "Reasons (NOT) to be cheerful".

A long-term US market bear, Montier says he has “never seen a market so highly valued in the face of overwhelming uncertainty”. It’s not that he is pessimistic as to what’s next – Montier says he has no idea if there will be a strong economic recovery or a second wave of Covid-19. The problem is there is no “wriggle room” if things go wrong, no “margin of safety” priced into US stocks. US markets, he says, have priced in a “truly Panglossian future where everything is for the best in the best of all possible worlds”.

Montier is always worth reading, but he may be over-egging things here. Investors are not indiscriminately buying US assets – many US banks, tourism companies and retailers have endured a torrid 2020. Only about a third of S&P 500 companies are above pre-pandemic levels and the average US stock has fallen in 2020.

US stocks look expensive relative to non-US markets, but that's largely accounted for by the high valuation afforded to the high-margin technology sector. Five technology companies – Apple, Amazon, Microsoft, Alphabet (Google) and Facebook – account for almost a quarter of the S&P 500's total market capitalisation. In contrast, tech companies account for a fraction of the European equity market. This sectoral composition explains much of the US-Europe valuation gulf.

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You can argue US tech giants are overpriced, but does that support Montier’s conclusion that investors have “forgotten about risk” and that the US market “appears to be absurd”? No.