Are we in a market bubble? It depends on what you’re reading or whom you ask.
Some valuation measures suggest the US market is more expensive than at almost any other point in history, perhaps beginning to match levels seen during the dotcom boom or before the 1929 crash.
Yet ask a technologist and they may tell you we are on the foothills of a once-in-a-generation investment boom, driven by advances in artificial intelligence (AI) through to the frontier of space commercialisation. This time it is different, they say.
As the billionaire investor Warren Buffett, a veteran of nearly eight decades of boom and bust, once said: ‘As bandwagon investors join any party, they create their own truth – for a while.’
For the average individual investor, the response to these versions of the truth can see-saw in our heads daily: ‘I should be reducing my exposure to all this froth. But I have a terrible fear of missing out.’
Are we in a market bubble? It depends on what you’re reading or whom you ask
I have been battling my FOMO – a nagging trait we investors must constantly fend off – and have taken steps that felt sensible for my portfolio and my aims.
They may not be right for you, and a financial adviser will be best placed to judge your specific situation.
For me, it is part of how an engaged DIY investor tweaks a portfolio to retain balance and improve outcomes – by being constantly aware of valuation.
1. Adjust geographically from expensive to cheap
I closely watch valuations and nudge my portfolio away from expensive stock markets and toward cheaper ones.
One measure is a comparison of current prices to average inflation-adjusted earnings over the past ten years.
Known as CAPE – cyclically adjusted price-to-earnings – it is a more sophisticated twist on the more commonly used price-to-earnings ratio. As with p/e ratios, a lower number suggests better value.
Historically, lower CAPE valuations have tended to be associated with stronger returns over the following decade or more. That is not a forecast of the future, but an observation.
As the table below shows, published by Taunus Trust, a German investment company, real returns from the US stock market have been around 12 per cent or 13 per cent for investments made when CAPE was below 15, but -0.2 per cent on the rare occasions it has been above 30. It is currently at 40, according to data from Research Affiliates.
Bear in mind that these annual returns factor in inflation making the 4.9 per cent figure for the UK, when CAPE was 15-20, pretty decent.
The UK market is currently on a CAPE of 17.5, according to Research Affiliates. I have angled my own portfolio toward the UK but also toward Europe, on a CAPE of 21.5, and emerging markets, which are on 22.2 but were much cheaper last year (more on this below).
CAPE vs subsequent 10-to-15-year annual average stock market returns: 1979 to 2026
| Country | 0-10 | 10-15 | 15-20 | 20-25 | 25-30 | 30+ |
|---|---|---|---|---|---|---|
| UK | 12.1% | 6.8% | 4.9% | 1.3% | 0.7% | n/a |
| US | 11.6% | 12.7% | 9.1% | 6.4% | 4.2% | – 0.2% |
| World | 11.5% | 8.2% | 6.6% | 5.1% | 4% | 1% |
2. Trim your winners
It is difficult to sell investments that have served you well. One compromise is to slice away some of the hotter areas of your portfolio, locking in profits and restoring some balance.
Andrew Oxlade has taken steps to taken steps to adjust his portfolio
A large proportion of the portfolio backs private companies, including Elon Musk’s SpaceX and Anthropic, the AI company behind Claude.
Edinburgh Worldwide, another investment trust run by Baillie Gifford, is also heavily invested in technological innovators.
I have trimmed my Scottish Mortgage exposure, taking it from 9 per cent to 6 per cent of my pension, and sold Edinburgh Worldwide.
I also plan to reduce the modest amount I have in the VanEck Space Innovators exchange-traded fund (ETF), which has handed me a 76 per cent return this year.
These decisions alone have left me feeling more relaxed about what might happen next.
3. Check your emerging markets funds for AI exposure
Emerging markets were regarded as cheap up until this year. A recent surge in prices has narrowed much of that valuation gap.
Much of the rally has been driven by three AI-related stock: Taiwan Semiconductor Manufacturing Company (TSMC), plus Samsung and SK Hynix of South Korea. The chipmaker stocks represent 14 per cent, 8 per cent and 7 per cent of the EM index, respectively.
You may be deliberately investing in emerging markets for exposure to these stocks, but I suspect most people are not.
I wasn’t and so have sold down some of the general EM funds I hold and reinvested some of the money into the BlackRock Latin American investment trust. The region remains cheap. Brazil, for example, is on a CAPE of 11, according to Research Affiliates.
Andrew Oxlade
Andrew Oxlade is a director at Fidelity Personal Investing, a former This is Money editor, and writes a regular column for This is Money on investment and financial planning.
4. Consider active over passive
Index-tracking funds have rightly surged in popularity due to their low cost and simplicity.
However, during times of fervour, you may find your future fortunes overly beholden to a handful of oversized stocks.
The so-called ‘Magnificent Seven’ in the US account for over a fifth of the MSCI World Index, which is commonly the basis for global tracker funds.
Nvidia is the top holding in the Legal & General Global Equity Index Fund, making up more than 5 per cent of the portfolio.
To labour the point, a £100,000 investment gives you about £5,000 of exposure to Nvidia. Would you choose to invest that much after the extraordinary rally it has enjoyed?
Funds that seek out undervalued stocks, known as value funds, could serve as a counterweight.
Dodge & Cox Worldwide Global Stock, which makes our Fidelity Select 50 list of favoured funds, only holds two of the ‘Magnificent 7’ stocks in its top 10, for example.
There is another, slightly more sledgehammer-like, approach to reducing your exposure to the concentration of stocks at the top end of the market – by putting some of your tracker money in so-called ‘equal-weighted’ index trackers.
They spread your money evenly across all stocks within a given index rather than reflecting company valuations, as traditional trackers do.
Examples include the Legal & General S&P 500 US Equal Weight Index Fund or the Invesco MSCI World Equal Weight ETF.
5. Increase your alternatives
Diversification is important at any time, but especially during periods of froth.
You might consider modest allocations to real estate or infrastructure investment trusts.
They may perform differently to stock market funds if a bubble were to burst. They also tend to pay relatively high levels of income.
The International Public Partnerships investment trust is one example that I hold. It offers a yield of 5.7 per cent, which isn’t guaranteed.
Gold remains the classic diversifier, especially during times of strife. I hold a small amount of my pension in the iShares Physical Gold ETC.
You could also consider funds and investment trusts that aim at wealth preservation rather than the best returns. The Personal Assets investment trust, which I hold, has just over a third of its portfolio in shares and 44 per cent in bonds.
6. Increase your cash holdings
For the very nervous investor, there is wisdom in moving some of the frothy profits you have realised into cash.
You could park your profits in money market funds, also known as cash funds. These now mostly yield less than 4 per cent, which is not guaranteed, and returns will change as interest-rate expectations shift.
The key problem with going to cash is that you may not hold your nerve if the market continues to inflate and you find yourself buying back in at a higher price. Or you may hold the cash indefinitely waiting for a crash that never comes.
Our Fidelity Be Invested survey found UK investors aiming for annual returns of 9.2 per cent a year over the next five years, yet they hold an average 17 per cent of their portfolio in cash.
These are all conundrums we face as we wrestle with our investment biases and shifting perceptions of value.
Most importantly, any revaluation of your portfolio is an opportunity to think about your actual aims – to consider the returns you need rather than those you want – and to make sure your investments still allow you to sleep at night.
Ultimately, I don’t think this time is different.
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