I’m undertaking a 1000-day reinvention project, blogging here daily to track my progress. In Friday Flash, I share an epiphany or aha moment from the past week.
Equity markets around the world have been making successive all-time highs this year. That’s not surprising, as in the past, the U.S. stock market has been within 5% of its high about 60% of the time. It has been in or near a bear market 25% of the time, leaving 15% of the time that it’s not very bullish or somewhat-to-very bearish.
Right now things are looking kind of questionable, so maybe we are going bearish (but who really knows). Yesterday, the S&P 500, NASDAQ, and Dow were all down by more than 1.5% (NASDAQ down more than 2%). And futures are pointing down again today.
Suddenly everyone is questioning the AI boom. Wait a minute, they say, OpenAI is burning through cash and even asked for a government guarantee so they could take out more debt to fund their expansion. Oracle is using massive amounts of debt to fund the construction of more data centers to support AI model training and inference. So is Meta, but they’re doing it in such a way — through special purpose vehicles — that it doesn’t show up on their balance sheet.
“Is it a bubble?” people ask. Does it matter? No, because it could be a bubble and it could keep inflating for two or three years. No, because even if it isn’t a bubble that doesn’t mean stocks will keep going up.
So what to do? Keep riding the all-time-high wave? And expect you can get out (and know when to get out) if a serious crash happens?
I listened to one of the cofounders of Long-Term Capital Management (LTCM) Victor Haghani on the Forward Guidance podcast yesterday. LTCM was a 1990s hedge fund run by Wall Street legends and two Nobel laureates, famous for using enormous leverage to profit from tiny bond-market inefficiencies. When the Asian financial crisis and Russia’s 1998 default triggered a global flight to safety, LTCM’s highly leveraged bets all moved the wrong way at once, threatening to topple not just the fund but its major bank counterparties. Fearing systemic contagion, the Federal Reserve put together a private rescue to unwind its positions. LTCM became a lasting symbol of how elegant models, crowded trades, and extreme leverage can turn a local shock into a global financial risk.
Now Haghani runs his own wealth management firm, and offers an ETF which access to his financial decision-making. His firm uses a very cautious and sober approach to money management: choosing low-cost equity ETFs representing different world regions based on their expected yields. These can be calculated in a variety of ways, including using the reciprocal of the Shiller PE ration (the CAPE, cyclically-adjusted price-to-earnings) ratio. Haghani uses a version adjusted for dividend payouts, assuming higher dividends mean lower growth given the business paying those dividends is retaining less earnings for investing into business advances.
History shows that the higher valuations you start out with, the lower the ten-year returns. In the near-term, with stocks at very high P/E ratios (no matter how you measure it), they may go up or down in the next month, six months, or year. But if you hold on long enough, you’ll almost certainly see poor returns.
Today’s Shiller PE Ratio for the S&P 500 stands at almost 40, higher than at any time other than the dotcom bubble, when it reached about 44.2 in December of 1999.
What to do as an investor? I’m tilting my portfolio towards value stocks, both in the U.S. and around the world, and I’m leaning more towards international than U.S. I’m adding commodity exposure, as most commodities other than precious metals have been in a bear market since 2022, and I’m focusing on TIPS for my fixed income, in expectation of inflation. I am considering adding more intermediate-term debt but I need to research it more before committing to that. I was burned in 2022 by my 60/40 portfolio, when everything went down at once.
Most prognosticators are forecasting the best returns in 2026 for emerging markets, then developed international, and finally U.S. stocks. Investing in EM stocks even via ETFs isn’t easy. If you buy a market-cap weighted EM fund like SCHE you end up with a version of the U.S. Mag 7 trade, as it’s overloaded with big tech (Taiwan Semiconductor and Alibaba, for instance). Buying a fund with some sort of value tilt may be better right here. It can also be useful to buy funds that exclude China or China and India, so that you can get to some other regions, or just buy regional funds like ILF (Latin America) and ASEA (Southeast Asia – Singapore, Malaysia, Indonesia, Thailand, the Philippines).
But even getting China and India is ok compared to sticking with the U.S. only. India’s stock market is almost as richly valued as the U.S., but the Indian economy has better demographic tailwinds. And China could come out of its deflationary depression soon. If you can stomach the Chinese political risk, it could be a good place to be.
After drafting this blog post I talked to my financial advisor and we made some slight changes to my allocations, but I’m already well diversified and not too heavy in AI bubble driven stocks. I pay a lot of attention to financial markets but so far that hasn’t translated into outperformance. In the last ten years diversification has been a millstone. I think in the coming decade I’ll be vindicated.