Since the stock market crash in March 2020, the S&P 500 has managed to rise over 90%. This means that it is currently far higher than its pre-pandemic price. By comparison, the FTSE 100 has only risen 37% in the same period. This can be explained by the number of tech companies in the S&P 500, including Microsoft, Google and Apple. These stocks have managed to reach astounding new highs since the pandemic, boosting the S&P 500 in the process. On the other hand, the FTSE 100 is full of banking and oil stocks, which have been heavily affected by the pandemic. But I now believe it’s the right time to buy UK shares instead of US stocks. Here’s why.
The S&P 500 looks set for a correction
The first reason I’m avoiding many S&P 500 stocks is because they look too expensive to me. In fact, the market currently has an average price-to-earnings (P/E) ratio of 35. They could continue to rise, of course. But this figure is not too far off the figure of around 43 when the dotcom bubble burst in 2000, which was caused by excessive speculation around tech stocks. Accordingly, I fear that something similar could happen this year.
The emergence of ‘meme stocks’, such as GameStop and AMC, also demonstrates that the price of many stocks is entirely detached from their weak fundamentals. This is another worry I hold about the S&P 500. This means that, although I continue to hold a number of US stocks, which I feel are not overly valued, I’m avoiding the majority right now due to these concerns.
So why UK shares instead?
In comparison to the S&P 500, the FTSE All-Share has a much lower average P/E ratio of just 16.5. Overall, this indicates that the stocks have a cheaper valuation. Even so, I am taking this comparison with a pinch of salt. Compared to the US, there are very few UK tech stocks. Such stocks often trade at large P/E ratios, because earnings are expected to grow strongly over the next few years. Instead, the FTSE All-Share contains a number of mature companies, in industries like oil and banking, which trade at fairly low P/E ratios and are also finding growth more challenging. As such, a low P/E ratio does not always mean better value.
Instead, I am mainly looking at the large number of takeovers of UK companies right now. These include Morrisons, which has recently been subject to an offer of 270p per share, a 50% premium from its pre-offer price. The British defence and aerospace manufacturer Meggitt was also subject to an 800p per share offer, far higher than its pre-offer price of 470p. This demonstrates that many private equity firms believe that UK shares are too cheap. This is why I’m buying.
Although I feel that many UK shares offer good value, it is still important to be discerning when choosing stocks. This is especially true because many UK companies are operating in struggling industries, such as travel or oil. These stocks may be particularly vulnerable to a stock market crash, and shareholders could be left with nothing. Accordingly, it is essential to choose companies with excellent fundamentals, in healthy industries and with strong management. A few of my personal favourites include Legal & General, Barclays and BAE Systems, yet there are, of course, plenty to choose from.
Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool’s board of directors. Teresa Kersten, an employee of LinkedIn, a Microsoft subsidiary, is a member of The Motley Fool’s board of directors. Stuart Blair owns shares in Barclays, BAE Systems and Legal & General. The Motley Fool UK owns shares of and has recommended Alphabet (A shares), Alphabet (C shares), Apple, and Microsoft. The Motley Fool UK has recommended Barclays, Meggitt and Morrisons and has recommended the following options: long March 2023 $120 calls on Apple and short March 2023 $130 calls on Apple. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.