Traditional equity investing has not vanished entirely, but it is now competing for attention with a party dominated by passive flows, mega-cap worship and the kind of optimism usually reserved for holiday sales lines.
Valuations and long-term returns: The old rules still whisper
Price-to-earnings ratios used to guide investors like streetlights on a foggy night. High starting valuations usually meant modest long-term returns. That rule of thumb never seemed exotic, only sensible.
Now, high valuations are celebrated as proof of American ingenuity. Passive inflows ignore fundamentals entirely. They buy because they must, not because anyone checked the mathematics. It is a system that hums along beautifully until the lights flicker. Long-term returns are not erased. They are simply postponed.
A market held up by a handful of giants
The US market has become a circus where a handful of AI and tech stars are juggling the whole U.S. equity and global index show, while the rest of the companies sit on folding chairs near the droppings of the elephant act.
One way to play it smart is to give those top ten tech and AI darlings their own little portfolio tent, while building a more diversified global allocation for everything else. That way, you enjoy the spectacle without risking a concussion from an overcrowded and seemingly precarious trade.
This current state of benchmark investing is not diversification. It is a monoculture disguised as safety. When multi-trillion-dollar markets rise or fall on the fortunes of a few companies, the illusion of stability is simply an illusion. Volatility waits patiently in the shadows.
US dominance in global indices
Global indices are supposed to give investors exposure to the entire world. In practice, they are increasingly Americanised, with US equities making up roughly two-thirds to 70 per cent of major benchmarks. Global diversification has become a polite fiction. The rest of the world is present, but mostly ornamental. Investors seeking true global exposure may find themselves unwittingly riding US mega-cap coattails, whether they intended to or not.
Capex, depreciation and the hardware arms race
Markets cheer as semiconductor and AI companies rocket toward stratospheric valuations. Meanwhile, the reality of their balance sheets is sobering. Investments in cutting-edge chips are depreciating faster than accounting schedules allow. For unprofitable AI companies, enormous capital expenditure is often financed with debt. The useful life of these assets may expire before the debt does, leaving investors staring at a financial tightrope without a safety net.
Michael Burry and Warren Buffett have long been raising eyebrows at paying premium multiples for businesses whose capital base erodes faster than the balance sheet implies. The party is fabulous, but it may be fuelled by champagne rather than substance.
The passive bid and Michael Green’s structural warning
Michael Green’s research on the passive bid is a reminder that this party has a playlist controlled by an algorithm, not a DJ. Retirement systems and index products pump money into markets mechanically. Fundamentals are irrelevant; price discovery is optional.
As long as contributions flow and employment remains healthy, the dance continues. But if flows reverse, the same momentum that sent the market soaring can work with equal force in the opposite direction. The music does not slow gracefully. It ends abruptly, and those who ignored the fundamentals might find themselves stepping on toes or worse.
Benchmark awareness as a constraint on investment management
Retail investors and superannuation funds face an added pressure. Benchmark-aware performance often takes precedence over absolute performance, capital preservation, compounding and drawdown control.
For those not interested in relative performance, several strategies merit serious attention if they are not already embedded within portfolio construction.
First, market-neutral approaches allow portfolios to benefit from inter-sector dispersion while lowering overall equity beta. This is the investing equivalent of walking through a crowded party without spilling your drink.
Second, downside protection should be treated as a structural allocation. Replacement trades, put-option spreads, long-volatility strategies, crisis-alpha allocations – many available via a growing list of capital-efficient ‘portable alpha’ solutions – may provide some buffer from extreme negative performance if/ when the floor suddenly drops.
Third, active management and diversification are indispensable. China, for example, is likely to produce global AI and technology leaders, yet its valuations remain far lower than US counterparts. Skilled active managers can uncover these opportunities and navigate markets where benchmark concentration distorts price discovery.
Finally, alternatives such as real assets and private markets offer distinct return streams and reduced correlation with listed equities. For those with experienced due-diligence teams, these exposures are akin to a VIP lounge at the party. They can be safer, quieter and more rewarding in the long run.
When the cycle turns
The market is self-reinforcing. High valuations generate strong returns, strong returns attract passive inflows and inflows push valuations even higher. It is an elegant dance as long as no-one trips. But history teaches that the music eventually changes. When it does, the forces that propelled markets upward could amplify losses. Concentration, narrow leadership and stretched valuations can transform a celebration into a stampede in moments.
Conclusion: Do not be the last guest standing
Traditional equity analysis has not lost its relevance. It has simply been overshadowed by a market dominated by passive inflows and a small group of superstar companies. Fundamentals still matter, but often with a lag. Valuations matter, but only when the automatic bid pauses. Risk exists, but it is increasingly hidden beneath the smooth surface of benchmark performance.
We have all enjoyed the extraordinary party in US large-cap equities, but when the music finally stops, do not be the last person standing with a lampshade on your head and your trousers around your ankles. Step away from the punch bowl, preserve your capital and leave with both dignity and your balance sheet intact.
Michael Armitage CAIA is principal of Fundlab Strategic Consulting Pty. Ltd.