When Valuations Run High: How to Think About Market Exposure

At a recent meeting, one of our clients raised a concern that we know is on the minds of many asset owners and trustees. With US equities making up such a large share of global indices, they worried that their portfolio might be overexposed to a market where valuations already look stretched. Add in political uncertainty in the US, ongoing wars in Ukraine and the Middle East, the risk of global trade disputes, and even the possibility of sentiment shifting quickly on technologies such as AI - and the picture can feel daunting. 

The questions were straightforward but significant: Is now the time to step back from the US? Are valuations too high? And what if a market correction is imminent? 

Our CEO, Tatyana, addressed these points in a way that we think is useful for any investor navigating similar concerns.

What follows is not investment advice and should not be taken as a recommendation to buy or sell any specific asset. Instead, it is intended to share general principles and observations about portfolio resilience and governance. 

Acknowledge the risks - but don’t overestimate your ability to avoid them 

Yes, US equities are expensive relative to many other markets, and political and geopolitical risks are real. It is important for clients to be mindful of these risks, particularly given how dominant the US is in global indices and in many investment managers’ portfolios. Overexposure to any single market is rarely comfortable. 

At the same time, it is worth remembering why the US has commanded such strong performance. The market has been supported by resilient corporate earnings, its dominance in research and development across breakthrough industries such as technology, healthcare and clean energy, and the relative strength of the US economy in recent years. These fundamentals help explain why investors have continued to pay a premium. 

Looking ahead, the opportunity set also matters. Equities may carry risks, but over the long term they continue to offer higher expected real returns than government bonds or cash, both in the US and globally. This is why, despite periodic volatility, they remain a cornerstone of long-term portfolios. 

But - and this is a crucial “but” - it is almost impossible to predict exactly when or how risks will trigger a correction. Markets are forward-looking, and they often climb a “wall of worry” for longer than many expect. 

Timing the market is a dangerous game 

Clients often ask whether they should sell down US equities and wait on the sidelines for a correction. History shows this is far harder than it sounds. 

If you sell too early, you may miss out on significant further upside, and once markets do fall, deciding when to buy back in is even more difficult.

One reason investors shouldn’t try to time the market is they run the risk of missing out on strong performance, which can seriously hamper long-term investment success. Historically, the best and worst trading days have tended to cluster in brief time periods, often during periods of heightened market uncertainty and distress, making the prospect of successfully timing the market improbable. 

The chart below from Vanguard shows daily global stock price returns from 1980 to the present. The vertical axis is labelled ‘Price return’ with numbers from -15% to +15%. The returns are shown as thin vertical bars. The gold bars show the 20 worst trading days and the green bars show the 20 best trading days. The majority of the best trading days occurred in years with negative returns and the worst trading days often happened in years with positive returns. 

Consistently timing market moves well is near impossible, even for professional investors. For asset owners, the risks of getting it wrong usually outweigh the potential rewards. 

Source: Vanguard; MSCI World Price Index from 1 January 1980 to 31 December 1987 and the MSCI AC World Price Index thereafter. The green bars highlight the 20 best trading days since 1 January 1980 and the gold bars highlight the 20 worst trading days since 1 January 1980. 

Focus first on liquidity, not prediction 

So, if timing the market is off the table, where should attention go instead? 

The starting point should always be ensuring you have enough liquidity. That means cash and near-cash reserves sufficient to cover your known obligations, such as upcoming capital commitments, operational costs, and debt repayments, as well as a contingency buffer for the unexpected. 

This discipline is critical because it ensures you are never a forced seller. In other words, you won’t be in the position of having to sell investments at depressed prices simply to meet your obligations. Avoiding this scenario is one of the most powerful protections you can put in place. 

Once liquidity is secured, the rest of the portfolio can be invested for the long term. This allows asset owners to ride out volatility rather than being derailed by it. 

Volatility can create opportunity 

There is another benefit to building a strong liquidity position: it enables you to act opportunistically. When markets do correct, valuations often become more attractive. Having cash on hand at these moments means you can deploy capital when others may be retreating. 

This requires discipline, but over the long run it is often these counter-cyclical moves, buying when valuations are lower, that contribute meaningfully to returns. 

It is also worth remembering that while we generally recommend trustees to avoid trying to time markets directly, many underlying fund managers will be making tactical decisions within their mandates - adjusting exposures, increasing or decreasing risk in response to conditions. Being mindful of this activity is important when making portfolio-level decisions: clients should focus on ensuring the overall allocation is resilient, while allowing managers to exercise their tactical expertise within the agreed strategy. 

Diversification still matters 

While liquidity is the foundation, diversification remains essential. If US equities do face a significant correction, having exposure to other geographies, asset classes, and investment styles can help to cushion the blow. Diversification won’t eliminate risk altogether, but it can make portfolios more resilient to shocks in any one area. 

Many of our client’s portfolios are long-term in nature, but they must also be flexible. Ensuring the right mix of liquid and illiquid assets, across regions and strategies, gives portfolios a better chance of meeting both spending needs and growth ambitions over time. 

The bottom line 

The temptation to respond to today’s headlines by making bold market calls is understandable, especially when valuations look stretched. But the reality is that very few investors can consistently predict corrections. Trying to do so risks missing gains on the way up and mistiming the recovery on the way back. 

Instead, investors should focus on what is within their control: ensuring liquidity, avoiding forced sales, maintaining diversification, and positioning themselves to take advantage of opportunities when they arise. 

Markets will always carry risks, some visible, some unexpected. The role of an asset owner is not to eliminate those risks entirely, but to manage them in a way that keeps objectives on track through all market conditions. 

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How PMCL can help 

Whether it is reviewing overall exposures, stress-testing liquidity planning, or assessing how diversified your portfolio really is, we can help clients feel confident that their investment arrangements are fit for purpose. 

If you would like to discuss how you might approach these issues, we would be delighted to hear from you.