Is the US really overvalued?

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Next time you bring up investing in the US stock market among friends, keep your buzzword bingo card handy to tick off a few stock phrases:

• “It’s too expensive to invest in the US, I’m looking for value elsewhere.”
• “Valuations are too high, I’m waiting for a pullback.”
• “Tech’s verging on bubble territory, the whole index is overvalued.”

Full house? Your prize is another evening wondering if it’s all actually true or just something we’ve got used to saying. Let’s see if we can add a bit of nuance to it all.

We’ll kick off by comparing the US to some other key international markets. On a price-to-earnings (P/E) basis, which shows us what investors are willing to pay for a piece of the index’s underlying earnings, the US sits far above the rest.

EMU: European Monetary Union. Source: Yardeni, as at 21 July 2025.

The stats point to the US being 54% more expensive than Japan and 79% more expensive than the UK. This is where a lot of conversations end, the takeaway being that the US market is just too expensive to invest in on a relative basis. That doesn’t tell the full story though.

It’s true that investors would be paying up, in terms of valuation, to own a piece of the US market. But, what do you get for that?

The answer is a lot more technology and communication services than the UK and a lot less in the way of financials and consumer staples, proportionally speaking.

Source: Vanguard, as at 30 June 2025.

Tech stocks now account for around 34% of the S&P 500 index, up from 12.3% in 2015 and leagues above the FTSE 100’s 4.3%. Tech naturally attracts higher valuations as the sector has high-growth DNA, evident over the past few years. The fact that the sector takes up a third of the US index means it pulls up the average P/E for the whole market. The same is true in the UK, with typically lower-valued sectors like energy and financials keeping overall valuations low because of how prominent they are in the index.

This all means it can start to make less and less sense to simply plonk two P/E ratios beside each other and grimace at the biggest one. You have to factor in what you’re being offered beneath the headline numbers, as Polar Capital Partners’ Colm Friel explains:

“One way I would illustrate the difference between the indices (US & EAFE; Europe, Australasia and the Far East) is to think of two warehouses that are the same size. One is 75% filled with luxury, high-end goods and 25% low-end commodities. The second is 25% high-end luxury goods and 75% low-end commodities.

“Somebody is selling the warehouses, full, on a price-per-square-foot basis, but you would not expect them to have the same per-square-foot price. That is a way of illustrating the fact that the US has proportionately more high quality, high growth, high return on invested capital (ROIC) businesses and proportionately less of the lower growth, lower ROIC businesses.”[2]

The point here is that, once we understand the sector composition effect of higher valuations, we have to think about whether the index deserves the premium it carries. For now, Goldman Sachs thinks the US does, citing companies’ steady earnings growth, less severe tariff impacts coming through in the near term than first thought and expected cuts in interest rates.[3]

What we do need to be careful of is disappointing earnings in select companies knocking investor confidence. When stocks are richly valued, it doesn’t take much to prompt sell-offs as we’ve seen with the likes of Tesla, Apple and even NVIDIA earlier this year. Case in point is Netflix whose stock dropped after this week’s trading update, despite beating revenue forecasts and lifting its full-year guidance. Those hefty valuations come with even heftier expectations and if the market isn’t impressed by the tech crowd’s numbers, the step-down in share prices could be significant.

Investors might not feel too worried about holding highly valued stocks as long as earnings continue to back up their P/Es. If we start to see a pattern of subpar results, though, it might be a different story. Higher starting valuations tend to be closely correlated to lower long-term returns, especially among large-cap growth companies and equity indices[4], so we do need to make sure we aren’t overpaying for future prospects.

Rather than seeing this as a sign to hop in and out of indices though, we can use valuations as a sign to get to know what’s really under the bonnet, ask why companies might sit at the higher end of the P/E scale, have a look at what other sectors are trading at and, crucially, make our own investment decisions. At the very least, it’ll give us a deeper understanding of seemingly entrenched valuation gaps to inform our decision making. That’s better than a throwaway quip about lofty US P/Es any day.

Sources:

[1] The Motley Fool, May 2025. [2] Polar Capital North American Fund Q&A, June 2025 [3] The S&P 500 is projected to rally more than expected, Goldman Sachs, July 2025 [4] Do valuations correlate to long-term returns? Examining US equities through various size and style indices, LSEG, January 2025

Important information

When investing, your capital is at risk. The value of your investments, and the income you receive from them, can go down as well as up and you may get back less than you invest. Forecasts aren’t a reliable guide to future results or returns.

Make sure to do your own research on what investments are right for you before investing or consider seeking expert financial advice. Please note that this article is meant for information and does not constitute any financial advice. This is not an offer, recommendation, inducement or invitation to buy, sell, or hold any securities, or to engage in any investment activity or strategy.