The US stock market is expensive by almost any measure, with the S&P 500 (^GSPC) hovering near all-time highs and valuations stretched across multiple indicators.
Analyst Joachim Klement of Panmure Gordon argues the situation may be worse than it looks, with the cyclically adjusted price-to-earnings ratio potentially at never-before-seen levels.
The CAPE ratio, which compares index prices to average earnings over 10 years, approached 44 during the dotcom bubble in 2000, a level the S&P 500 is currently trading near.
Klement adjusts that figure further to around 68 when accounting for the fact that earnings themselves are well above their long-term trend.
That means the US market is effectively experiencing a price bubble layered on top of an earnings bubble, a historically rare and precarious combination.
Artificial intelligence is the obvious culprit, with a small group of technology-focused stocks dominating investment indexes as companies race to outspend each other on AI infrastructure.
As John Maynard Keynes famously warned, markets can remain irrational for longer than you can remain solvent, making it dangerous to simply move to cash and wait.
The smarter approach, according to market observers, is ensuring sufficient diversification so that portfolios are cushioned on the downside without fully sacrificing upside gains.
Alexander Chartres, fund manager at UK-based Ruffer LLP, points to Chinese technology stocks as one area of compelling relative value given their far lower valuations compared to US counterparts.
“If you think about who provides cloud computing globally, it’s basically the US and China, with a handful of names in both countries,” Chartres says.
Chinese tech companies carry decent revenue growth and significant AI exposure, but have been beaten down by weak sentiment and political risk, creating an opportunity according to Chartres.
The iShares MSCI China Tech ETF (CTCE LN) offers broad exposure to the theme, with top holdings including Alibaba Group, Tencent Holdings, and Baidu (BIDU), carrying an annual total expense ratio of 0.45%.
For investors wanting to move away from technology entirely, the United Kingdom presents another diversification opportunity that has been largely overlooked during the AI investment frenzy.
Tomiko Evans, chief investment officer at Crossing Point Investment Management, describes UK equity income as a strong diversifier for portfolios feeling overweight on tech.
“The UK market has a very different sector composition from global equity indices, with greater exposure to financials, energy, healthcare, consumer staples and other cash-generative businesses,” she says.
Evans specifically highlights the Murray Income Trust (MUT LN), a closed-end fund focused on sustaining and growing dividends over time, which recently underwent a management change bringing a more cash flow-focused approach.
The fund’s largest holdings at the end of May included Lloyds Banking Group (LYG), Barclays (BCS), NatWest Group, Aviva, and GSK, and the trust trades at roughly a 6% discount to net asset value with a dividend yield of approximately 4%.
Beyond equities, Chartres identifies energy as a genuine diversification tool in a world where inflation volatility has made bonds an unreliable hedge against market turbulence.
Chartres notes that while the recent Gulf War illustrated how energy spikes can drag down both stocks and bonds broadly, the fossil-fuel sector itself tends to benefit from such disruptions.
Oil services companies may also prosper over the longer run as nations invest in energy infrastructure to guard against future Gulf disruptions, though Chartres acknowledges “the oil market could be soggy for a long time.”
The iShares Global Energy ETF (IXC) offers exposure to the sector with top holdings including ExxonMobil (XOM), Chevron, and Shell, carrying a total annual expense ratio of 0.4%.
