The Biggest Valuation Spread In 40 Years? | #175

Episode Summary

Executive Summary: The episode argues that U.S. stocks are not uniquely deserving of their premium valuation and that current U.S. prices are extreme relative to global markets. Using CAPE ratios and historical comparisons, the host contends the valuation spread between the U.S. and foreign stocks is near a 40-year extreme, making home-country bias in portfolios a potentially costly active bet on mean reversion not happening.

Main Topics: U.S. valuation premium vs. the world (Priority: 5/5): The host compares the U.S. CAPE ratio to global averages and argues the U.S. market is significantly more expensive than foreign markets right now. History of relative valuations (Priority: 5/5): He shows that over the long run the U.S. has not consistently traded at a premium; historical valuation leadership has flipped back and forth between U.S. and foreign stocks. What drove foreign market expensiveness in the 1980s (Priority: 4/5): The 1980s foreign-market premium is attributed largely to Japan’s bubble, which lifted non-U.S. valuations well above U.S. levels. Mean reversion and future returns (Priority: 5/5): The episode reinforces the idea that low starting CAPE ratios tend to precede stronger 10-year returns, while high valuations tend to predict weaker future returns. Home country bias (Priority: 5/5): The host critiques investors’ tendency to overweight their own country’s stocks, arguing this is an emotional and often unjustified active decision. Valuation-based global allocation (Priority: 4/5): The practical takeaway is to evaluate country exposure objectively and consider whether the current U.S. overweight is truly warranted.

Key Arguments: The U.S. market’s current valuation is very high relative to global markets, with a CAPE around 30 versus a global average around 16. The U.S. has not historically deserved a persistent valuation premium; since 1980, average CAPE ratios for U.S. and non-U.S. stocks have been roughly equal. Periods when foreign stocks were more expensive were often driven by specific bubbles, especially Japan in the 1980s, rather than broad structural superiority. Current valuation spreads are among the widest in history, which increases the risk that U.S.-heavy portfolios are making a large implicit bet against mean reversion. Most investors overweight their home market, and in the U.S. that often means holding more domestic stocks than a passive global allocation would suggest. Cheaper markets, especially the cheapest quartile of countries, have historically offered better prospective return opportunities than expensive markets.

Data Points: U.S. long-term CAPE ratio: around 30 - Current valuation level of the U.S. stock market Average CAPE ratio of countries around the globe: around 16 - Current average valuation across global markets Historical average CAPE premium (U.S. vs. rest of world since 1980): about 22% for both - The host says average valuations have been roughly equal over the long run Historical valuation premium: zero - He states the U.S. has not had a persistent valuation advantage historically Time spent more expensive than the other: basically a coin flip - Relative expensiveness of U.S. vs. foreign stocks since 1980 Japan CAPE ratio in the 1980s: almost 100 - Explains why foreign stocks were much more expensive in that decade Cheapest quartile of countries CAPE ratio: about 11 - Valuation level for roughly the cheapest 25% of investable countries Discount of cheapest quartile vs. U.S.: 62% lower than the U.S. - Shows how cheap the lowest-valued markets are relative to the U.S. Poll result: investors overweighting U.S.: 84% - Percentage of Twitter respondents allocating more to the U.S. than a passive index would imply Approximate number of investable countries: 45 - Used to define the cheapest quartile of markets

Pivotal Quotes: "Today, however, marks one of the widest valuation spreads in history with foreign markets trading at much cheaper levels than that of the US." — Meb Faber: Core thesis of the episode on current relative valuations "The historical valuation premium has been zero." — Meb Faber: Summarizes the long-run U.S. vs. foreign valuation comparison "Are you really willing to make that bet." — Meb Faber: Challenge to investors who overweight U.S. stocks despite high valuations

Implications: Investors should question U.S.-heavy portfolios as a large active wager on expensive assets outperforming cheaper foreign markets. The episode suggests broader diversification and valuation discipline may improve long-run outcomes.