Understanding Market Valuations
Markets initially bounced back from the challenges of 2022, driven by steady economic growth and lower inflation. While these factors have fueled investor confidence, history proves that long periods of rapid growth are often followed by slowdowns or corrections.
Source: Topdown Charts, LSEG
The cyclically adjusted price-to-earnings (CAPE) ratio helps measure market valuations by comparing stock prices to company earnings. As of January 2025, the CAPE stands at 36.98, near the peak of the 2021 rally (38.53) and more than double the pre-1990 average of 14.1.[3] This level ranks among the highest in the CAPE’s 150-year history, showing the widening gap between stock prices and actual earnings.
Source: Robert Shiller
Supporters of the current market rally cite innovations such as artificial intelligence (AI) and new trends in capital investment as reasons for high valuations. However, similar arguments were made during the dot-com boom, shortly before markets suffered a decade of poor returns.
Signs of Risk Amid Optimism
Investor sentiment, as tracked by the Levkovich Index from Citigroup, reached extreme levels of optimism in December 2024, last seen in 2021.[4] Historically, such excitement has often been followed by market downturns.
Meanwhile, major financial institutions are lowering their expectations. Goldman Sachs predicts the S&P 500 will see average annual returns of just 3% over the next decade, while Bank of America is even more cautious, expecting 0-1% growth.[5] Additionally, corporate filings reveal that U.S. executives are selling more shares than they are buying, which may indicate doubts about future growth.[6]
While the timing of market corrections is uncertain, volatility is likely. Investors with too much exposure to stocks risk significant losses, especially since a 50% drop in value requires a 100% rebound to break even. Additionally, the stress of market swings can cause emotional decision-making, leading to poorly timed trades.
Reducing Risk Through Diversification
One way to prepare for potential market turbulence is to spread investments beyond public stocks. Private markets, including private equity, private credit, and real estate, provide solid alternatives that can help bring more balance to a portfolio.
Historically, private equity has delivered about 4% higher annual returns than public stocks.[7] Private credit, meanwhile, has shown not only better returns but also steadier performance than public debt, with some studies indicating that it is about half as volatile.[8],[9]
Additionally, smaller companies, often a focus of private market investments, have outperformed large corporations in recent years. Unlike overvalued large-cap stocks, these businesses present opportunities for better entry points and long-term growth.
Preparing for the Future
History suggests that the best time to adjust a portfolio is before market conditions shift. While optimism remains high and commentators continue to argue that "this time is different," smart investors are quietly preparing for possible instability.
A balanced strategy involves reducing exposure to expensive public stocks, particularly in overvalued sectors, and increasing investments in alternatives that provide better value and downside protection.
With over two decades of experience in private markets, we help you identify and manage investment opportunities that support long-term financial success. To explore how private market investments can strengthen your portfolio, schedule a call with one of our financial advisors.