Is it a bubble?

The US stock market is now, by almost any measure, very highly valued relative to history. This is especially true of the largest businesses in the market.

In sharp contrast, medium-sized companies outside the US are trading well below long-term average valuation levels.

Our strategy’s benchmark, the MSCI All Country World Index (our emphasis added) is now around 67% invested in the US. The triple concentration of the global index in large, US and momentum-driven businesses has left most investors significantly less diversified than they may appreciate. The only free lunch in investing is diversification, and most investors have sleepwalked into considerable thematic, style and geographic concentration.

During periods of market euphoria, many people invest their hard-earned savings the way five-year-olds play football – everyone chasing the ball around the pitch, and no one playing their position.

For a stock picker, the equivalent of chasing the ball around the pitch is to allocate a disproportionate amount of time analysing the most high-profile company of the day. Arguably that is where the marginal value of one’s effort is the lowest; if it is now the most well-known, well-covered and well-liked company in the world – what value is our analysis likely to add? It is certainly not where significant undervaluation is likely to be found.

'What were you thinking?'

Scott McNealy, the former CEO of Sun Microsystems, famously said after the DotCom bubble had deflated Sun’s valuation from a bubbly 10 times revenues:  ‘At 10 times revenues… what were you thinking?’¹ Even after the largest loss of capital for a single firm in stock market history, Nvidia is trading around 25x sales.²

That’s food for thought for index investors who have over 4% of their capital invested at these prices.

Instead of chasing the ball alongside the crowd, we look for unloved areas of the market where we can invest. We do so with a capital preservation mindset, worried about preserving our capital first and growing it second. To do this, we seek to invest in a broad collection of lowly valued businesses and try to diversify by fundamental risk factors (geography, business model, customer exposure etc.). In this current market regime we are predominantly invested in businesses outside the US and further down the market cap spectrum than the index.

In the short-term, our significant difference from the broader market (a near 100% active share) might make us look foolish, but in the long run we think conservative, rational and price-disciplined investing wins out.

Most expensive in history

To put some numbers on the contrast, while we are witnessing one of the most expensive stock markets in history with the Nasdaq on an earnings yield of 2.6%³, our strategy’s portfolio of businesses is on an earnings yield of c.10.5%⁴. Our portfolio pays a dividend yield of c.4.4%⁵; we have a strong preference for net cash businesses and those run by families and owners who eat their own cooking. Most of our investments have substantial tangible asset backing that we believe can provide a cushion to our investment in a downturn. If a business is trading below its liquidation value, it may not keep up with markets on the way up, but if things go wrong, we can exercise aggressively our rights as shareholders to encourage a significant portion of our capital to be returned to us.

While simple measures of return on capital can be misleading at best and procyclical at worst, we note that value and quality are not mutually exclusive and certainly not antonyms. We invite clients to scour our holdings to spot what we consider to be the iconic brands, natural monopoly infrastructure assets, prime urban properties and other ‘high quality’ assets that we have assembled at material discounts to our estimations of fair value.

There will likely come a point where US large caps become cheap again: Apple and Microsoft were on 10% earnings yields in the not-so-distant past. We retain the flexibility to deploy our capital into these businesses if valuations become attractive but for now, we see a risk of material capital impairment from sky-high valuations.

Is it really a bubble?

Simple metrics to sense-check valuations of a stock market versus long-term history include:

• The market value relative to GDP (the Buffett indicator)
• The market value relative to cyclically adjusted earnings (the Shiller PE)
• The market value of companies relative to their book values (price to book), their tangible book values, or more appropriately their estimated replacement costs (various measures of Tobin’s Q)
• The good old-fashioned price to earnings ratios or dividend yields.   

Investors can review these measures for the U.S. over long time periods and make up their own minds.

But below we sense check the valuation of companies in the broadest of terms by checking their valuations relative to the value of goods and services they sell to their customers (Enterprise Value to Sales).

Enterprise value to sales of MSCI World, Growth and Value indices

Expensive by every metric

By every metric we can think of the US looks very expensive in both absolute and relative terms. It is baking in tremendous optimism and stands in sharp contrast to many markets around the world.

It should be clear from the chart above and the other metrics we cited that aggregate valuation levels for `growthier’ areas or the market are back at levels that have only been witnessed during prior bubbles.

Many narratives have been provided to justify a US market that continues to soar above longer-term valuation levels⁶, but as students of financial history will know, the most expensive four words in investment remain ‘this time is different’.  Sharp eyes will spot that International Mid Cap companies (MSCI EAFE Index) in the chart above look surprisingly attractive and this is where we have found the best opportunities, and deployed most our capital.

Please note strategy risks:

• Currency (FX) Risk - The strategy can be exposed to different currencies and movements in foreign exchange rates can cause the value of investments to fall as well as rise.
• Pricing Risk - Price movements in financial assets mean the value of assets can fall as well as rise, with this risk typically amplified in more volatile market conditions.
• Derivative risk - the strategy may use derivatives to reduce costs and/or the overall risk of the strategy (this is also known as Efficient Portfolio Management or "EPM"). Derivatives involve a level of risk, however, for EPM they should not increase the overall riskiness of the strategy.
• Counterparty Default Risk - The risk of losses due to the default of a counterparty on a derivatives contract or a custodian that is safeguarding the strategy's assets.
• Charges from capital - Some or all of the strategy's charges are taken from capital. Should there not be sufficient capital growth in the strategy this may cause capital erosion.

Footnotes

¹The full McNealy quote, via Bloomberg Businessweek  1.4.2002:  “At 10 times revenues, to give you a 10-year payback, I have to pay you 100% of revenues for 10 straight years in dividends. That assumes I can get that by my shareholders. That assumes I have zero cost of goods sold, which is very hard for a computer company. That assumes zero expenses, which is really hard with 39,000 employees. That assumes I pay no taxes, which is very hard. And that assumes you pay no taxes on your dividends, which is kind of illegal. And that assumes with zero R&D for the next 10 years, I can maintain the current revenue run rate. Now, having done that, would any of you like to buy my stock at $64? Do you realize how ridiculous those basic assumptions are? You don’t need any transparency. You don’t need any footnotes. What were you thinking?”
²Bloomberg data as at 28.1.25
³Bloomberg data as at 28.1.25
^{4, 5}Jupiter data as at 30.12.2024. Quoted yields are not a guide or guarantee for the expected level of distributions to be received. The yield may fluctuate significantly during times of extreme market and economic volatility.
⁶The most digestible explanation of liquidity impacts we have read come from Rockefeller Global Family Office CIO Jimmy Chang, here https://www.rockco.com/strategic-insights/the-sugar-high/

Important information

This marketing communication is intended for investment professionals and is not for the use or benefit of other persons, including retail investors.

This communication is for informational purposes only and is not investment advice. Market and exchange rate movements can cause the value of an investment to fall as well as rise, and you may get back less than originally invested. Initial charges are likely to have a greater proportionate effect on returns if investments are liquidated in the shorter term.

Past performance is no guide to the future. Company examples are for illustrative purposes only and are not a recommendation to buy or sell. Quoted yields are not a guide or guarantee for the expected level of distributions to be received. The yield may fluctuate significantly during times of extreme market and economic volatility. Awards and ratings should not be taken as a recommendation.

The views expressed are those of the author at the time of writing, are not necessarily those of Jupiter as a whole and may be subject to change. This is particularly true during periods of rapidly changing market circumstances. Every effort is made to ensure the accuracy of the information provided but no assurance or warranties are given.

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