Navigating market extremes: Looking beyond the conventional
There are many ways to assess stock markets’ valuations, but one of the most widely used is the price-to-earnings (P/E) ratio. And if one is a student of P/Es, it’s an alarming sight, says Hugh Selby-Smith, co-chief investment officer of Talaria Capital. According to Selby-Smith, P/Es have reached levels seen only five times in the past 70 years. “The current valuation landscape leaves investors vulnerable,” he explained, citing data from Barclays and Bloomberg that highlight the risks of today’s high equity prices.
A growing concern is the increasing concentration of capital within public markets, particularly in the US. “Not only has country concentration increased,” Selby-Smith noted, “but so has single-stock concentration.” The dominance of a few mega-cap companies has fueled strong momentum, but history suggests that such momentum tends to fade after a significant run-up. “More often than not, momentum returns fade in the year after a big rally like this one,” he observed.
Selby-Smith pointed out that while momentum has been a dominant factor in markets, its sustainability is questionable given historical trends. “Momentum is a pretty good factor, however, given its strength over the last 12 to 24 months, it’s important to consider what that suggests from a historical context going back to the 1950s,” he said. This analysis raises concerns about whether today’s rally is sustainable or vulnerable to reversal.
For investors looking to build resilience, traditional safe-haven assets such as bonds may no longer be the optimal hedge. With inflation persisting above target levels, correlations between equities and bonds have shifted, diminishing the historical diversification benefits of fixed income. “The correlation to the majority of equity market concentration makes bonds a less attractive diversifier,” Selby-Smith contended.
Instead, he argues that investors should look beyond traditional asset classes. Private markets, infrastructure, and alternative investments offer potential solutions for portfolio diversification. “Other asset classes offer good options,” he stated, suggesting that these investments provide uncorrelated returns and stability in times of market stress.
A compelling argument for shifting allocations to alternative assets is their relative valuation. “Some private market assets are the cheapest they’ve been in around 20 years,” Selby-Smith pointed out, referencing Bloomberg data adjusted for five-year inflation forward rates. “And stability is cheap,” he added, reinforcing the notion that now may be an opportune moment to allocate capital to less-volatile, long-term holdings.
Selby-Smith also emphasised that investors should be strategic about where they allocate their incremental dollars. “The only factor in town has been momentum, but we need to ask where the next best opportunities lie,” he noted. “Given the setup and where we’ve come from, advisers should be thinking about where the incremental dollar is best allocated and who they want to accept meetings from in the next three months.”
Liquidity constraints remain a consideration for investors venturing into private markets, but Selby-Smith stressed the trade-off between access and performance. “While liquidity is a concern, the benefits of uncorrelated returns and enhanced stability in volatile markets cannot be overlooked.”
Talaria Capital, the firm Selby-Smith co-founded, specialises in global equity investments with a focus on generating consistent income and capital appreciation. The firm employs a value-oriented investment approach, seeking to provide long-term wealth growth while mitigating market volatility. Talaria’s point of differentiation is that it sells put options over its shareholdings — every position in Talaria’s fund begins life as a put option — to generate a source of return that is not correlated with traditional income sources.
For financial advisers and institutional investors, the message is clear, said Selby-Smith: The era of relying solely on traditional equity and bond allocations is over. Diversification strategies must evolve to include a broader range of assets that can weather market shifts.
“We’re at a juncture where investors need to rethink risk and return,” Selby-Smith concluded. “Public markets remain essential, but true diversification now requires looking beyond the conventional.”
As investors navigate an increasingly complex and uncertain landscape, incorporating alternative asset classes may be the key to achieving long-term stability and sustainable returns.