A lot of UK investors (myself included), have increased their exposure to the US over the past year or so. The performance of the S&P 500 has been strong, and gaining some geographical diversification is never a bad thing. Yet despite the index breaking to fresh record highs, I’ve spotted some red flags that are concerning me.
Tariff tensions are back
At the start of April, the announcement of tariffs on global trading partners led to a sharp decline in the S&P 500. As the situation improved and a 90-day negotiation period was established, the market rallied. Yet we’re now in a position where this grace period is ending, with letters being sent out to nations detailing potential tariff rates.
Of course, it’s possible that any backlash means the US administration kicks the can down the road again. However, if not, the market could revert to panic mode as investors absorb the potential negative impact that tariffs could have on the US economy.
Interest rates remaining high
Thanks to strong labour market data and a lack of inflation concerns, investors are expecting the US Federal Reserve not to cut interest rates as aggressively as previously thought. Typically, the lowering of interest rates is a good thing for the stock market. A lack of reduction could put pressure on stocks to continue heading higher.
For example, I’m staying away from Realty Income (NYSE:O). It’s a real estate investment trust (REIT) that owns and manages freestanding commercial properties across the US. Impressively, it pays out its dividend monthly!
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Its revenue comes almost entirely from long-term rental contracts with tenants. Yet the revenue is offset partly by financing costs. It borrows money to acquire properties and grow. High interest rates mean debt remains expensive. If investors need to adjust their view on rates staying higher for longer, sentiment towards Realty Income could become less favourable.
However, some might be happy to ride out any potential share price correction due to the generous 5.61% dividend yield. The share price is up 8% over the past year, indicating it can be resilient despite challenging market conditions.
Valuations look stretched
The final red flag I’m observing is the valuation of companies within the index and even the index average. For example, a good metric is the price-to-earnings ratio. It’s currently 29.69 for the S&P 500. This is well above the fair value benchmark figure of 10 I use, and almost double the corresponding ratio figure for the FTSE 100.
This doesn’t mean that the index can’t continue to rally, as not all stocks within it are overvalued. But it does highlight the need to be selective when it comes to allocating money.
