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Is it time to broaden your investment horizons?

As we move past the pandemic and into recovery mode, many investors are asking about how to structure their portfolios, and whether they need to be concerned about potentially inflated stock market valuations. Julian Broom, our Chief Investment Officer, and Charlie Buxton, our Portfolio Manager, offer some insight into whether the time is right to broaden your investment horizons.

When it comes to the shape of the post-pandemic investment landscape, it’s a somewhat mixed picture. Globally, certain indicators are looking positive with vaccines beginning to change the course of the pandemic across Europe, the US economy having its forecast GDP numbers revised higher and central banks and governments not in any hurry to withdraw monetary and fiscal support.

Yet stock market valuations are questionable. In fact, some long-term measures for US stocks – such as that created by Robert Shiller – see levels similar to that seen during the tech boom. And who can forget what followed; one of the most famous busts in history. Even if you take a more conservative view and use a one-year forward earnings valuation, multiples are significantly higher when compared to what’s played out historically in the way of long-term averages.

It’s of course accepted that valuations don’t automatically foretell what will come in the way of real returns in the short term, but history has shown us that valuations and returns over the long term are linked. And if we use that premise to look at a valuation of the S&P price index, currently standing at over 22 times, then the average annual return over the next ten years would be nil.

There are different views as to whether high valuations hamper long-term returns. On the one hand some analysts argue that low interest rates, as we’re seeing currently, support valuations. But is this an artificial environment? It certainly feels that way, and a situation with sustainably higher earnings growth and lower bond yields seems rather far-fetched.

On the other hand, the opportunity for a boom in the last half of 2021 is more than possible. Household savings ratios have hit record highs in the UK and US. As economies open up and spending fuels the bounce back further, the long-term impact for growth could be significant.

When looking for a balanced debate it’s also worth bearing in mind that valuations are somewhat impacted by different sectors. After all, when looking at US markets it’s a handful of tech and non-essential consumer goods which are currently ‘lifting’ overall valuations, although Q1 results are supporting these projections. And it may be that in other sectors – like financials – the market could be underestimating earnings prospects, especially with loan losses from the pandemic lower than expected.

So, opportunities in stocks remain, particularly when you start to consider markets and sectors which might be under-priced. Whilst a narrow portfolio may have performed well in the past, the time may be right for diversification.

In considering a more diverse portfolio, it’s useful to look at it across several levels, including asset class, regions, and a blend of managers with different styles and approaches. Indeed, a tilt to value companies can help deliver strong performance, harnessing sectors such as financials as mentioned above.

Ultimately, in order to fully guard against excess volatility like we saw in March 2020, diversification must be factored in at all levels of portfolio construction. Having a robust approach to downside protection is just as important as being able to partake in the upside, when markets are more bullish.

To discuss any aspect of your own investment portfolio please get in touch.