Canadian stocks typically trade at valuations well below that of U.S. ones, especially with the current Wall Street euphoria.Julia Demaree Nikhinson/The Associated Press
The U.S. stock market has lost touch with reality.
Consider the evidence: Over the past couple of weeks, investors have seen strong indications that the U.S. economy is slowing. They have also witnessed President Donald Trump’s shocking decision to fire the head of the Bureau of Labor Statistics after she reported the unflattering economic figures.
Yet Wall Street keeps motoring along, despite the slowing economy and despite worries over how the White House might try to censor future data releases. Why the ebullience? The bulls’ latest argument is that an economic slowdown could actually be good news because it might prompt the Federal Reserve to cut interest rates.
Um, right. Granted, anything is possible in the short term. However, the prospects for strong returns from U.S. stocks over the next few years are looking increasingly dubious. This may be a good time for investors to start thinking about where they can find sanity in an insane market.
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Spoiler alert: It is not in an S&P 500 index fund. By just about any of the standard measuring sticks – price-to-earnings ratios, dividend yield, equity risk premium – the U.S. stock market is beyond frothy.
A straightforward way to gauge the degree of froth is to look at price-to-sales ratios. This metric compares a company’s share price to its current revenues. A low price-to-sales ratio suggests that investors are cautious about a business’s prospects and expect its future sales to grow only slowly. In contrast, a high price-to-sales ratio indicates that investors are optimistic about an enterprise’s outlook. For whatever reason, they expect its sales to boom.
Right now, investors’ hopes are sky high. The typical stock in the S&P 500 sports a price-to-sales ratio of about 3.3. This is remarkably elevated by historical standards. Only a few years ago, the typical price-to-sales ratio for a U.S. company was less than two. Companies in many other parts of the world still trade around similar levels. If U.S. stocks were to fall back to such valuations, the S&P 500 would lose roughly a third of its value.
What has made investors so willing to pay extraordinary prices for U.S. stocks? The driving force in recent months has been the swelling enthusiasm around artificial intelligence.
Major AI players such as Alphabet Inc, Meta Platforms Inc. and OpenAI are pouring hundreds of billions of dollars into everything from computer chips to data centres to energy production. “This investment surge accounts for about half of U.S. economic growth in the first half of 2025,” economist Paul Krugman wrote this week. “Without that surge, we would probably be looking at an economy at stall speed, that is, growing so slowly it could easily slip into recession.”
Scott Chronert, equity strategist at Citigroup, acknowledges that skeptics can view the current market mania as an AI-induced bubble. However, he argues it could actually be the early stages of a long-running bull market if AI can begin to deliver real benefits to the broader economy.
“The past two years of this bull run have been led by the direct beneficiaries of the build out in AI capabilities,” he writes. “This is likely to persist for the foreseeable future. But eventually a handoff will need to happen whereby Tech/AI users reap the benefits of current AI promise.”
Perhaps that will come to pass. However, there are at least three reasons to be cautious. First, current stock prices already incorporate a lot of high hopes. Second, there is as yet no evidence of that broad increase in real-world productivity that Mr. Chronert is looking for. Third, even if AI begins to deliver big benefits, it seems unlikely that everyone will wind up a winner in the AI sweepstakes – quite possibly, one or two companies will dominate the field.
Investors might want to look elsewhere for sanity. Stocks in Canada, Europe and elsewhere typically trade at valuations well below that of U.S. stocks. Investors who want to sidestep the current Wall Street euphoria can buy a broad swath of such international stocks through exchange-traded funds offered by the likes of iShares and Vanguard Canada.
If you’re more attracted by individual stocks, there is nothing wrong with focusing on solid dividend payers. The folks at Veritas Investment Research recently published their always interesting Report on Dividends. Among the yield plays they like are a pair of power producers – Canadian Utilities Ltd. and Fortis Inc. – as well as Canadian Utilities’ parent ATCO Ltd. If you buy the argument that AI’s insatiable demand for power will benefit electricity producers everywhere, these companies could enjoy an extra boost from galloping demand for generating capacity.
If you don’t care about dividends, a more contrarian approach would be to load up on Berkshire Hathaway Inc. Warren Buffett’s flagship has been losing ground since the great investor announced early this summer that he was stepping down. Yet there is a lot to like about the company’s broadly diversified mix of industries, from railways to insurance to Apple Inc., as well as its huge cash pile. At its current price, it looks like a solid value.
Full disclosure: I own shares of Berkshire Hathaway and Fortis.