US stocks are firmly in bubble territory, marked by historically high valuations and exuberant sentiment. Yet, according to recent analysis, this bubble is more likely to expand than burst in the near term. The US stock market’s current condition isn’t just a result of tech dominance—it’s reflective of broader structural factors unique to America’s economy.
A Distinctly American Bubble
Excluding the “Magnificent 7” tech giants, the valuation gap between US and European stocks remains substantial. Even after adjusting for sector weights, US equities trade at significantly higher price-to-earnings ratios across multiple sectors, including consumer goods, financials, and utilities. The key driver? Growth expectations. Analysts predict US sectors will deliver 2–3 percentage points more earnings growth annually than their European counterparts in the coming years.
However, whether this growth differential justifies a 40% valuation premium is debatable. Historical data suggests such a gap is unsustainable over the long term, as global growth rates tend to converge.
Absolute Valuations at Alarming Heights
Beyond relative valuations, US stocks exhibit high absolute valuations. Robert Shiller’s cyclically adjusted price-to-earnings (CAPE) ratio is near its historical peak, rivaling levels seen during the dot-com bubble. Additionally, the equity risk premium has dipped close to the “red zone” identified by valuation expert Aswath Damodaran, signaling limited compensation for investors taking on market risk.
Sentiment Signals Frothy Market Conditions
Investor sentiment supports the bubble thesis. Indicators like Citigroup’s Levkovich sentiment index and Bank of America’s asset manager survey show heightened optimism. The portion of managers overweight US stocks has reached an 11-year high, while the proportion expecting US equities to outperform globally is at a decade-high.
Why the Bubble Might Keep Expanding
A robust US productivity streak, strong corporate profits, and a growth-oriented policy stance under the incoming Trump administration are fueling the bubble’s persistence. Lack of compelling alternatives also drives overinvestment in US equities.
What Should Investors Do?
While the bubble might inflate further, surprises can trigger abrupt corrections. High cash holdings, perhaps double the usual levels, could offer a buffer. Diversifying into international stocks and short-term fixed-income instruments may also reduce exposure to overvalued US equities.
The author’s personal portfolio reflects this cautious stance, with significant cash reserves and international investments. While this isn’t investment advice, it underscores the need for strategic adjustments to navigate an overheated market.
